Deep Dive
Shownotes Transcript
Pushkin.
The CSI 300 index is at about 4,000. That is an index of large onshore Chinese stocks. That is the same level it was at 10 years ago. But it hasn't really been flat. It's been a roller coaster ride since. And the roller coaster has left a lot of people thinking that Chinese stocks are uninvestable. Today on the show, maybe that's not true.
This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I'm Rob Armstrong coming to you from Unhedged World Headquarters in New York City. I am joined by Unhedged's own China expert, Aiden Reiter, reporting from his sickbed in Brooklyn. Aiden, are you up for it today? Yeah.
You know, my throat hurts, but I'm here and happy to be here. And I am also joined by the excellent Ruchir Sharma, who is a frequent contributor to the Financial Times on all matters, economics, finance, markets, and especially the emerging world. Ruchir, welcome to the show. Thanks, Rob, for having me. So why don't we start with you walking us through? We're slightly China equity skeptics here.
And so it's good to have someone who disagrees on the show. In short form, give us the case for exposure to Chinese equities.
Rob, first to put this in context, I've been a big China bear for a long period of time, which is that I've written often, including in my columns in the FT, as to why I think that China's growth rate is likely to slow down to a trend growth rate of 2% or 3%, and why the Chinese economy may in fact never be able to catch up with the American economy, at least in our lifetime.
And I've been writing about the Chinese debt bubble over the past decade or so and also about the Chinese demographics, that how the combination of debt demographics and much more state control is likely to keep the Chinese economy from growing far from its target of 5%. So that's the context. So have you had a change of heart?
No. So I think that I still believe in that wrong. But the point that I was trying to make in that column is that this extremist view that China is uninvestable to me is wrong. You...
began the show by referring to the CSI index as being a benchmark and how that's done nothing over the last decade or so. Well, that's true, obviously, as a fact. But a lot of places where money has been made in China, including some of the large tech stocks,
are not included in some of these standard benchmarks or were not included for a long period of time. So the Tencent, Alibaba's and all these other ADRs listed in the US are not there in some of these indices. And even in some of the indices which included them, such as the MSCI China Index,
which a lot of foreign investors look at. These were included rather late after they'd already seen a pretty substantial price spike. So one that investing in China gets a bit of a bad name because of these indices that people refer to. So that's point one. The second point is the fact that
The Chinese economy has slowed down a lot. The nominal GDP growth rate, even officially reported now, is below 5%. So we've seen a dramatic slowdown in Chinese economic growth rate. That's hurt profits, obviously. And that's one big reason why the Chinese stock market
has underperformed so significantly. And for me, as I said, the MSCI China is just a better, more holistic benchmark to look at than the CSI 300 or whatever the domestic benchmarks are. So if you look at that index, in fact, it had a very sharp up move, in fact, a parabolic move in the late 2010s. And since then, it has given up a significant part of those gains. The reason it's given up those gains is
is because the Chinese property market went bust, the economy was in trouble, and also because he got much more state intervention. You know, with Xi Jinping being much more interventionist and in 2020 when he...
went after Alibaba in a way, that was a signal to many foreign investors that this is a place which is getting dangerous to do business. So I'd say that that's really what happened. For me, what you just said really hits the very core of the uninvestability argument, which is simply that your property rights as an equity holder are a bit unclear. Right.
You don't know what you own. And that's true both in the kind of ADR structures of U.S. listed Chinese stocks and with Chinese stocks themselves. To what degree are you subject to the whims of the party, as it were?
Yes. So I think there's a price for everything. And this is where the change of heart took place, which is that if you, you know, like, if you recall, I'd also written a piece back in December last year, calling this concept of American exceptionalism to be a big bubble.
And the reason I wrote that was the fact that the gap in valuations between America and the rest of the world had reached levels which to me seemed far too stretched. And also the fact that the amount of capital just flowing into America versus the rest of the world just seemed very extreme as well.
The Chinese market just happened to be the cheapest market in the world on the other side of the spectrum. So in America, at one end of the spectrum being the most expensive market in the world, and the Chinese market came to be the cheapest market in the world, trading at almost half the valuation of what the American market was. So there's a price for everything. Now, what happened after the Trump victory in November is that some very large pension funds in the U.S.,
took almost a political decision that we just cannot be in China. The risks are far too great. We're going to have Trump go after China. So a lot of people just did a fire sale where they just said, just get us out of China at any price. And I know some large sovereign wealth funds, even outside the US, took a similar decision that let's just reduce our exposure to China given the very bad experience we have had with returns.
and two with the fact that now with Trump's coming in the office so my sort of case then as I've been building like over the last few months is that listen I agree that there are many risks of investing in China but to dub the entire market as uninvestable the second largest equity market in the world I think is too extreme a step and these fire sales going on where just get us out of China because we don't want to be there I think is the wrong approach so
Maybe it's worth revisiting why Chinese equities are surging right now and around the time of your column that has drawn so much interest. As you point out, there was this big fall, especially after October when China announced it was going to do stimulus and a lot of investors became interested in Chinese equities again. We see this big rise partially because China looks like a more appealing tech sector with DeepSeek.
but also partially because there's these actions taken by Xi Jinping that would seem to make China more investable. Specifically, a government symposium where Alibaba founder Jack Ma reappeared after years of kind of being out of the limelight. And then other cosmetic fixes, right? So China telling its domestic insurance agencies to start buying more Chinese equities. So to some people, that was a really good sign, right? Oh, Xi is changing his tone. This is going to be better. To others...
This seems cosmetic, right? What has fundamentally changed? So just curious if you think anything has actually really changed the last couple of months that makes China more investable or undercuts the previous quote-unquote uninvestable case. One, I think that what's happening around the world is the fact that because of Trump,
it's forcing some leaders to change their attitude, which is that they realize that they're going to face a much more hostile external environment. So they need their domestic economy much more to counter that. So I think that there is a reaction to that. And Xi Jinping's attitude, change may partly have to do with it.
The second thing is that the deep-seek moment has made people realize that China is still able to innovate. China is still able to produce cutting-edge technology. So at least those two changes have taken place. Now, you're right that as far as the economy is concerned,
the changes really haven't been meaningful because the entire stimulus that they announced in September and October just seemed like band-aid. But I think that, you know, there's a case for a nuanced argument here, Aidan, which is that I'm not trying to say that I'm going to bet my entire home on, you know, Chinese equities. All I'm trying to say is that, you know, like this American exceptionalism went way too far.
And at the other end of the spectrum, the pessimism about China has gone too far and we are bound to see some rebalancing in that. And the classy example I keep quoting, again, something that I wrote about for the FT's pages, is that just look at the difference between Tesla and BYD. BYD has similar profitability if you look at ROEs and stuff, and yet its valuation is a fraction that of Tesla, that it began the year with Tesla with a PE of more than 100 and
BYD with a P of 15 or 16 or something. It's interesting that you bring up Tesla BYD. I think a lot of investors would also argue Tesla is not investable because it doesn't necessarily respond to fundamentals. And now has a very empowered leader at its helm. That is very interesting. And curious, you mentioned the stimulus. As you named, we're waiting on that stimulus. A lot of what really revived market spirits was
promises of said stimulus. I find it interesting, and I'm curious your thoughts on this, that we're still getting a second sector rise despite not having that stimulus, right? Everything, again, has seemed cosmetic or just, you know, dressing up certain debt proposals they'd already had on the books. So, I mean, what do you expect from China's stimulus? So, Rob, do you have any thoughts on China's stimulus? I'll let Ruchir take that one. No, but so therefore, the rally this time has been very concentrated in the Chinese tech sector.
The other stuff in China really hasn't fired. And I think that there is a template for this, that if you look at Japan all through the 1990s,
The Japanese equity market came off a huge bubble. The economy slowed down tremendously. A lot of economists think that what we're seeing in China is the Japanification argument, but that did not make Japan uninvestable because it was a large equity market. It had big rallies, again, based on stimulus hopes, which would often fade. But then you had a lot of winners and
Those days in the export sector, which came out of Japan. So I think that the main argument I'm taking is with this absolutist view that many pension funds, sovereign funds, and even the people in the US are taking that China is uninvestable. I found that argument very compelling because in Japan's long deflationary slump,
a lot of good stock pickers made a lot of money in Japan. There were excellent Japanese companies. And if you knew how to pick them and you didn't buy the wide indices, you could do quite well there in the 90s, in the early 2000s, right up until today. You just couldn't buy the whole index. Exactly. I think, you know, that's also the case I'd make for China. And as I said that, you know, the other sort of
uh, side of taking this is that I just feel what's happened with America in terms of the flows that have gone there have been an extreme, uh, in terms of what's happened. The fact that the American stock market, uh, came to be nearly 70% of the global MSCI benchmark, you know, for an economy, which is still less than 30% of global GDP. So those are extremes. Like the dollar came to be the most expensive it had been on some measures. Uh,
post-Britain towards history. So the idea is that capital will go to other places and China should be part of the mix. But not that China should be the only country, but I think as we're discovering how quickly things can change, all of a sudden sentiment on Europe has switched, but there are so many other emerging markets also on which sentiment can switch and China should be part of the mix.
It's interesting you name that, right, in this moment, because it seems like there's something of a paradigm shift happening already, right? European equities are ripping right now. The U.S. is flat to down. A lot of this is from, you know, the big changes we're seeing from the Trump administration. Earlier, you mentioned that it would be harder for the U.S. to really tariff China or, you know, the world to sever itself from China.
Trump has done 20% tariffs on China so far. It seems like his administration is not willing to negotiate with them. At the same time, China has retaliated, but in a very, very needle-like way, really trying not to anger the bearer of the United States. I had a great call yesterday with a guy called Arjun Ditche. I'm going to get his name wrong. Arjun Ditche, who founded the emerging markets business at GMO. I put to him a lot of these sort of political risk questions about China.
emerging market investing. And he made a very simple, very interesting point, which is the nice thing about political risk is that you can actually hedge it. In other words, diversification works with political risk. Like you can't get away from the risk of what the Fed is going to do or global economic conditions. But if you have a diversified portfolio, you can actually hedge
political risk away and get paid for taking it when things are working. That was the point I hadn't really thought about clearly before, and that really helped me see the way you might add a China to the portfolio. We've written on Unhedged how if you actually look at China and Japan right now, China's arguably in a worse economic condition, right? China's not as rich as Japan was in the 90s. Its population demographics are
arguably worse. Its ability to intervene in its market is, you know, some could say greater, some would say worse. Just curious if you were thinking about, you know, somebody who's thinking about Chinese equities and what there is political risk in, what is a good asset to own, you know, what are the considerations? Is it all sector oriented or are there other things that you're thinking about in terms of what makes a quote unquote good Chinese equity to own? Yeah. So firstly, you know, the one big difference with Japan is valuations.
that the Japanese market had got so nuttily valued by 89, 90, that a lot of the underperformance of Japan was just connected to overvaluation rather in Japan, right? Because Chinese equities came to be at 10 times earnings or whatever at the beginning of this year. So it just had a massive difference as far as the starting point is concerned. Now, how do you invest in China is the key thing. Because in Japan, the key in the 1990s was owning these exporting companies, which did really well and all that.
In China, I think that the issue is in terms of that, I think we have to be very focused on companies that are shareholder friendly. Because if there is a problem in China that it's made it, you know, so-called uninvestable for some people, it's that the companies there are just not that shareholder friendly. They tend to do massive equity dilutions.
even if they have a lot of free cash flow, which I pointed out too, they don't necessarily pay them out in dividends. They don't do buybacks of the kind that the US companies do or even some of the European companies have started to do. So I think the issue is to look at which companies are unlikely to dilute you, which companies have decent dividend yields. So I think that it's about having a mix of those companies which are able to generate reasonable cash flow, have some policy for sharing
paying that back to shareholders and also some of the state-owned companies where the dividend yield is very high. You know, about 7-8% type dividend yield companies you'll get in some of the Chinese SUEs or so. So I think it's a combination of that is what you need to look at China. And I think that the other thing which could possibly help China is if this dollar weakening period has begun.
Because I think that's a very important constraint that many emerging markets have had, including China. That they've been a bit constrained in the amount of stimulus they can do because they've been grappling with a very strong dollar. The strong dollar has put upward pressure on some of these countries' interest rates or accelerated capital outflows. But if the dollar's on a weakening trend, that gives many emerging markets a lot more leeway to be able to stimulate interest.
including China. You know, the Trump administration, one of the good things about the Trump administration, you can argue, is that it is unwittingly... Helping emerging markets. Yeah, by any chance. I don't think that was in the campaign speech. Exactly, but I think it's...
So that's one. And then two, it sort of makes Xi Jinping much less of a hawk for his own domestic constituency because he realizes he needs this domestic constituency because the export market is going to be so much more challenging for him. I want to widen the frame a little bit, Ruchir, to other emerging markets. And one of the emerging market trades I've spoken to several managers about and that investors, I think, are excited about is
is the sort of out of China trade, that this emerging trend where people are moving, diversifying their manufacturing value chains out of China to places including Vietnam or India, and that those stock markets are just starting to see the benefits of that. Have you thought about that trade, the kind of ex-China or flight from China trade? And do you think it has legs? Yeah.
Yeah, again, this is a pattern that I've written about a lot in the last couple of years. But I feel that the case for those other emerging markets is a bit different, Rob, if I may say so. I think the case for those markets is that, you know, look at, for example, a market like Indonesia. It's down 20% in dollar terms, really, in the last six months. A lot of that is because Indonesia is being forced to maintain very high real interest rates, partly to defend its currency.
And I think that as the dollar weakens, then it releases that pressure on these countries, whether it's Indonesia, Philippines or other countries to maintain such high real interest rates. And that liquidity, I think, could be a big boost for these emerging markets. Roshir, just as a question to close this excellent conversation.
Isn't there a risk that tariff policy by the Trump administration strengthens the dollar? And we see the kind of negative opposite of the argument you're making about a weaker U.S. economy and a weaker dollar benefiting emerging markets. That was the conventional wisdom going into this year. But I think that, you know, like it's as Trump would himself say, for me, common sense is what should prevail. That is, the U.S. is carrying out policies which are bad for it.
I think that to expect the rest of the world to get hurt more by it was an irrational thought process. So I'd say that in terms of the risk today is more with the U.S. And I think there's a very important difference also here that the U.S. economy weakens today
A lot of people think that what about the knock-on effect of that for the rest of the world? But I think the very important difference this time is this, that in the past, whenever the U.S. economy did well or the U.S. stock market did well, it lifted other countries along with it. This time, what's happened is that as the U.S. went up, it sucked up other capital from other countries. Right.
So we've had this staggering amount of capital outflows from some of these countries. And so I think that this time, as the U.S. softens or weakens, the other countries are unlikely to suffer much. And this is a big difference from past cycles that I think people are overlooking. We'll be right back after a short break.
That the chip rush is greater than any gold rush. And I think many investors have adopted a similar logic in trying to invest in what they describe as the picks and shovels of AI. And so building up the data centers and buying the chips and supplying the power has been a higher confidence bet in terms of the early stages of this artificial intelligence boom. To hear more from Chris Miller, author of Chip War, subscribe to PGM's The Outthinking Investor in your favorite podcast app.
Listeners, welcome back. This is Long and Short, that portion of the show where we go long things we like and short things we don't. Ruchir, do you have a long or a short for us? I think I mentioned on the show, which is that I'm long BYD short Tesla. Yes, a pair trade. We love those. Aidan, what's your long or your short today? I am long the quote unquote China replacement contract.
conversation. So our colleague Tej Parikh wrote a great piece about Vietnam and why it's doing so well, why a lot of China's capital might be moving to Vietnam. It got a lot of people who did not agree. I think a lot of people will be choosing their own favorite hobby horse in that race. And I'm just long the conversation. I'm excited to take part of it. Listeners, we'll be back in your feed in just a few days. And until then, stay sharp out there.
Unhedged is produced by Jake Harper and edited by Bryant Erstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer.
I'm Rob Armstrong. Thanks for listening.