Lessons From the “China Miracle”

Back in the mid-2000s, investing in China was all the rage.

Memories of the dot-com bust faded. U.S. investors piled into Chinese stocks, looking to make their next fortune.

At the MoneyShow conferences, editors of China newsletters attracted thousands of investors to their talks.

Hundreds of others took cruises to China to witness Shanghai’s modern skyline in person.

Even Warren Buffett entered the fray, buying $488 million worth of PetroChina (NYSE: PTR) stock in 2002. The stock went on to become the world’s first trillion-dollar company. (Luckily, Buffett sold his stake at a $3.5 billion profit before the market collapse.)

In short, Americans were set to make millions in China.

For me it was, as Yogi Berra put it, “Déjà vu all over again.”

After all, the “China miracle” was my third mania. I had lived through the boom and bust of the Russian stock market in the late 1990s. I had witnessed the bursting of the internet bubble in 2000.

By the time the mania in Chinese stocks rolled around in 2005, I knew in my bones how the story would end.

Today, every single one of those China newsletters is long gone.

And the Shanghai Stock Exchange turned out to be the single worst-performing major stock market in the world of the past 10 years.

Chart - Global Stock Index 10-Year Performance

Meanwhile, the S&P 500 nearly tripled, the Nasdaq went up nearly fourfold and Japan’s Nikkei 225 more than doubled. Even laggard Europe’s Stoxx 600 jumped by 64%.

What Happened to the “China Miracle”?

Other stock markets have stagnated over the decades.

The Dow Jones Industrial Average didn’t budge between 1966 and 1982. Today, Japan’s Nikkei trades at a little more than half of its peak, reached in 1989.

Still, the lagging performance of the Chinese stock market is puzzling. After all, this was an economy that had tripled in size over the past 10 years.

So why did China turn out to be such a lousy investment?

First, China’s domestic stock market has a reputation as a casino. Dominated by gamblers, the market does not behave rationally. No wonder some of the Western world’s best investors have had their heads handed to them.

Consider the case of Anthony Bolton – “the Peter Lynch of the United Kingdom.” Bolton was the top fund manager of his generation. He cranked out returns of 19.5% a year over a 28-year career.

In 2010, Bolton came out of retirement to launch a much-ballyhooed China fund. But Bolton threw in the towel after just four years, admitting, “I was wrong about the market in China.”

Second, many listed Chinese companies are state-owned enterprises. Every Chinese enterprise has a red phone with a direct line to the Communist Party. Making money for shareholders is not a priority. Kowtowing to Communist Party apparatchiks is.

Third, yes, China has had some high-profile technology success stories. Together, Tencent (OTC: TCEHY) and Alibaba (NYSE: BABA) are worth about $1 trillion. But neither is listed in mainland China.

Is China Worth a Contrarian Bet?

Fifteen years ago, the sky was the limit in China’s stock market.

Today, the case against investing in China is just as compelling.

China’s already questionable growth rate has slowed from 10% to 6.5%. The country’s debt has soared. It is losing the trade war with the U.S. The Hong Kong protests question the legitimacy of the Communist Party of China.

Now, I am not a big fan of China. But I see two reasons that support the few remaining China bulls.

First, when market sentiment reaches an extreme, it’s usually a good idea to go the other way. Asset prices tend to revert to the mean.

Second, China’s share of global stock indexes is growing every year. That guarantees that more foreign money will flow into China over the next decade. And indexes don’t care about trade wars, valuations or my opinion about Chinese state-owned enterprises.

The bottom line?

China’s next decade will likely be better than this past one.

But there are many better places to invest your money.

Good investing,

Nicholas

Tagged