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China’s Great Wall of Worry

Myths vs. Realities

05 June 2019
3 min read

What You Need to Know

China’s rise as a preeminent economic power makes it impossible for globally minded investors to ignore. With the integration of China’s domestic-listed equities and bonds into major global indices, the potential of investing in the broad economy is increasingly opening to the world. It’s time, then, for investors to familiarize themselves with misconceptions that can distort the view of China’s economy and corporate landscape. We survey several myths about the Chinese market—from a looming debt bubble to export dependence to an inability to innovate—and explain what investors need to pay attention to in order to make informed decisions as they tap China’s opportunities.

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3rd
Rank of China’s bond market
among countries, by size
$30.8B
Alibaba online sales,
Singles' Day 2018
2014
The year China declared war
on pollution
Authors
Hua Cheng, CFA| Director—Asia Credit Research
John Lin| Chief Investment Officer—China Equities
Stuart Rae| Chief Investment Officer—Emerging Markets Value Equities

Despite projections that this giant will eventually surpass the US and claim the mantle of the world’s largest economy, China remains a developing country with its own unique brand of economic peculiarities.

While China’s central government has ably shepherded the country to unprecedented expansion, it still exerts a dominant and sometimes heavy-handed influence on the economy and markets. Many investors are understandably unnerved by China’s perceived mountain of debt, its giant shadow-banking sector, and a potential real estate bubble. Still others worry that the country is overly dependent on low-cost exports and infrastructure projects, rather than domestic consumption and innovation. And environmentally responsible investors are uncertain about the steps China is taking on its environmental front.

Such an investment climate may appear overly exotic and too risky. However, before deciding to pass over China, investors need to familiarize themselves with several misconceptions that can distort perspectives about China’s economy and corporate landscape.

Capital Markets

Myth: China’s capital markets are liberalizing.

Reality: Lingering restrictions and government intervention mean markets won’t resemble those of the US or Europe anytime soon.

It was another sign of the wave of foreign investment destined for China’s capital markets. In February, MSCI announced plans to quadruple the weighting of Chinese equities in its benchmark indices this year.

But days later, MSCI decided to drop Han’s Laser from its indices because of regulatory intervention: ownership of the stock was about to touch a long-standing government-imposed ceiling on foreign investment. Buy orders halted. The turn of events illustrates both the opportunity and the complications from the opening of China’s equity and bond markets to foreign investors.

Adding Onshore Securities

Seeking a more accurate reflection in trading indices of China’s giant but underrepresented capital market, prominent global bond and equity benchmarks are increasingly adding China’s onshore securities. As a result, foreign inflows into its stock market are projected to double in 2019 to US$89 billion, according to Citigroup. Cumulative net flows have already reached US$114 billion through April 30, 2019 (Display).

Foreign Flows into China’s Stock Market Have Surged

Cumulative “Northbound” Net Flows into China’s Markets*

Foreign Flows into China’s Stock Market Have Surged

Through April 30, 2019
* “Northbound” flows represent flows into onshore Chinese equities (A-shares) via the Shanghai-Hong Kong Stock Connect and the Shenzhen-Hong Kong Stock Connect, known collectively as China Connect. IT is used as a gauge of international money flowing into China A-shares.
Source: Bloomberg

Today, China’s A-shares market, which is composed of stocks that trade on the mainland exchanges, looks a lot like the US stock market circa 1965. It’s still unevenly regulated, marked by patchy governance of its listed companies, and dominated by retail investors, whose tendency to buy high and sell low can exacerbate volatility.

But thanks in large part to the inclusion of Chinese stocks in the MSCI Emerging Markets Index in 2018, the liberalization of access to China’s A-shares market and its regulatory framework—such as the strengthening of trading-suspension rules—has progressed much more rapidly than expected.

Past performance, historical and current analyses, and expectations do not guarantee future results. There can be no assurance that any investment objectives will be achieved. The information contained here reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed here may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AB or its affiliates.

The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

About the Authors

Hua Cheng is a Senior Vice President and Director of Asia Credit Research. She joined AB in 2011 and now oversees the credit research capabilities in Asia. Cheng is also responsible for covering the technology sector in China, as well as banks and nonbank financial institutions in the Asia Pacific region, with an emphasis on China’s financial system and credit market. Earlier in her tenure at AB, she was an equity research analyst covering Chinese and Hong Kong banks. Cheng was previously an auditor at PricewaterhouseCoopers, where she audited China’s financial institutions. She holds a BA in finance from the Capital University of Economics and Business (Beijing) and an MBA from the Columbia Business School. Cheng is a CFA charterholder.

John Lin is the Chief Investment Officer of China Equities. He has been a Portfolio Manager for AB China Equities since 2013 and for Emerging Markets Value Equities since 2021. From 2008 to 2022, Lin served as a senior research analyst, responsible for covering financials, real estate and conglomerate companies in Hong Kong and China. He joined the firm in New York in 2006 as a research associate, covering consumer services companies for US Small & Mid-Cap Value Equities. Previously, Lin was a technology, media and telecom investment banker at Citigroup. He holds a BS (magna cum laude) in environmental engineering from Cornell University, and an MBA from the Wharton School at the University of Pennsylvania, where he earned the distinction Graduation with Honors. Location: Singapore

Stuart Rae is Chief Investment Officer of Emerging Markets Value Equities since 2023 and Chief Investment Officer of Asia-Pacific Value Equities, a position he has held since 2006. He is also a long-standing Portfolio Manager for China Equities. Previously, Rae was CIO of Australian Value Equities from 2003 to 2006. He joined the firm in 1999 as a research analyst covering the consumer sector, initially working in New York and London before moving to Sydney in 2003, Hong Kong in 2006 and Melbourne in 2021. Before that, Rae was a management consultant with McKinsey for six years in Australia and the UK. He holds a BSc (Hons) in physics from Monash University, Australia, and a DPhil in physics from the University of Oxford, where he studied as a Rhodes Scholar. Location: Melbourne

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