There are few good ways out of China’s stock slump
By Felix Martin
November 22, 20246:59 PM GMT+7Updated 2 days ago
U.S. President Donald Trump attends a bilateral meeting with China's President Xi Jinping during the G20 leaders summit in Osaka, Japan, June 29, 2019. REUTERS/Kevin Lamarque Purchase Licensing Rights, opens new tab
LONDON, Nov 21 (Reuters Breakingviews) - In the 1979 disaster movie “The China Syndrome”, a design flaw at a nuclear power plant threatens a catastrophic meltdown in which the reactor core will burn all the way through to the other side of the earth.
Investors in Chinese equities have lately been enduring a China Syndrome of their own. Over the last three-and-a-half years, the benchmark CSI 300 Index has lost nearly a third of its value, even as the S&P 500 Index (.SPX), opens new tab basket of leading U.S. stocks has soared to new all-time highs.
With Donald Trump set to return to the White House backed by a Republican-controlled Congress, should investors brace for Chinese stocks to shrivel further – or is now the moment to take a contrarian view?
It is not hard to find reasons to steer clear. Having averaged 9% a year in the two decades leading up to 2019, China’s economic growth rate has roughly halved since 2020. Even in the boom times, the link between equity returns and growth was weak. But the cracks run much deeper than that. China’s investment-led growth model, funded by successive waves of credit expansion, appears to have run out of steam while leaving the economy loaded with sky-high debts.
The country’s once-booming real estate sector has succumbed to an epic bust, shrinking the value of most households’ main asset and stranding local government finances. Meanwhile, broad measures of domestic Chinese prices have been sliding for more than two years, completing a toxic circle and raising the spectre of debt-deflation. No wonder the bears say its economy is structurally impaired.
A line chart showing price levels in China, by quarter
Yet alongside these well-known handicaps, investors in the People’s Republic benefit from some equally notable tailwinds. It is the world’s second-largest economy, it is the undisputed leader in global manufacturing and trade, and - according to, opens new tab the Australian Strategic Policy Institute - the global champion in research and innovation in no fewer than 57 of 64 critical technologies. Indeed, the European Union is now considering asking Chinese companies to transfer technology in return for subsidies, the Financial Times reported this week.
Financially, meanwhile, China is the world’s largest external creditor economy, with an excess of foreign assets over liabilities of some $4.3 trillion. Its annual current account surplus has dipped below $100 billion only once in the last two decades and added a cool $250 billion last year. Such economic and financial fundamentals give the Chinese authorities a degree of flexibility over economic policy that few other governments can match.
China bulls can take further heart from valuation and sentiment. Even after a 25% jump since authorities in Beijing announced monetary stimulus measures in mid-September, the CSI 300 Index still trades at just over 15 times earnings. India’s BSE Sensex Index (.BSESN), opens new tab trades at 22 times, while the S&P 500 Index is valued at a multiple of 27.
It’s only four years since the planned $37 billion initial public offering of Jack Ma’s Ant Financial attracted orders of $3 trillion from prospective investors – equivalent to nearly 3% cent of global GDP at the time – shortly before regulators cancelled the offering. Investors evidently weren’t too bothered by the Middle Kingdom’s structural challenges back then. If ever there were a case of prices making opinions, China’s boosters argue, this is it.
A column chart showing price-earning multiples for indexes in China, India, and the United States
Yet even if technical considerations make a short-term punt look tempting, the case for the People’s Republic as a longer-term investment is a trickier matter. The GOP clean sweep in Washington ironically makes it more likely that the world’s two superpowers will be able to strike an economic deal. That’s because on its central contentious issue – China’s management of its exchange rate – the incentives of both sides are increasingly aligned.
An agreement under which Beijing agrees to revalue the yuan against the dollar in return for averting an all-out trade war would meet the key demand of Trump and his advisers for an end to what they see as an artificial currency advantage which has brought American manufacturing to its knees.
Such a deal - call it a “ Mar-a-Lago Accord”, after the Plaza Accord which saw U.S. trade partners agreed to devalue the dollar in the mid-1980s – would also align with China’s reluctance to reflate its economy through demand-side stimulus, in favour of attempting a more controlled recovery via a supply-side transition to new drivers of growth built on more advanced industry and technology. It would support China’s long-held ambitions for the yuan’s emergence as a genuine international reserve currency as well.
 Multiple lines showing each currency's share of foreign exchange reserves
For Chinese equities, such a détente might sound like unequivocal good news. It would be anything but. While it would free China’s stock markets from their current burden of geopolitical risk, it would imprison them in Beijing’s deflationary restructuring strategy instead.
Absent the looser monetary conditions and higher inflation that a weaker currency would permit, corporate and local government balance sheets would have to sweat off their excessive debts over time. Growth in corporate revenue and earnings would suffer a prolonged slowdown until the economy had worked out its imbalances.
Such a scenario would not disappoint all investors. A strong-yuan, sound-money strategy would be music to the ears of holders of Chinese bonds. Well-targeted venture capital investments in China’s industrial upgrading, meanwhile, could pay off handsomely. But for asset allocators exposed to most constituents of the Shanghai and Shenzhen stock exchanges, the period after a “Mar-a-Lago Accord” would be a long, hard slog.
There is of course an alternative possibility. China might opt to ditch its controlled approach and plump for radical reflation instead. That would require a devaluation of the yuan, killing any currency accord. Such a volte-face would supercharge Chinese stock markets – at least in local currency terms. But the resulting disruption to global trade and capital flows would almost certainly be extreme.
In that scenario, equity investors well beyond China will need to don their radiation suits as well. “Today, only a handful of people know what it means…” warned the original movie poster for “The China Syndrome” of the meltdown at the heart of its plot, “Soon you will know”.
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