To Invest or Not To Invest in China?

Alpha Ba, CFA
Global investment circles have recently been convulsed by regulatory, social, and political developments emanating from China. We present our take on these trends below.

Conclusion - September 14, 2021

At Pillow Investment Partner, we believe in prudently seeking profitable equity investments exposed to China’s ongoing economic growth.

Given the backlash against China in part of the investment community over the past few months, we believe the anti-China sentiment is now consensus. However, despite the uncertainties and challenges, we are attracted to China’s low double-digit RoE, decent EPS growth and diversification potential, supported by sustainably strong GDP growth. In our view, in order to reflect policy uncertainties and fraught relations with the US, rather than eschew investing in China, we should seek investment opportunities in China in a prudent and disciplined way, reflecting both the risks and the potential returns. This can be done in three ways: i) direct stock pickings aligned with CCP’s long term policy goals; ii) targeted sectoral ETFs in China (semiconductors, EVs); iii) indirect stock pickings in global markets. To “hedge” these China-related risks, we could also consider raising our crypto weights or investing in Japan.

Our core convictions about China

  1. Maintain the Chinese Communist Party (CCP) in power;
  2. Maintain President Xi Jinping in power;
  3. Both President Xi & the CCP draw their legitimacy from China’s continued economic success;
  4. President Xi has absolute control over all levers of power (executive, legislative, judiciary, army, media) in China;
  5. Chinese policies (economic, social, international relations, Made in China 2025, etc.) will be used to advance the above goals.

MSCI China in the World today

  1. Performance: MSCI China has been a serial underperformer vs. MSCI ACWI or MSCI USA over the short, medium, and long term
  2. Volatility: MSCI China has displayed higher volatility than any other major market, including MSCI EM over any period
  3. Valuation: MSCI China is the cheapest market on PER and the 2nd cheapest on PBR, while offering below average RoE. As well, MSCI China offers relatively low implied EPS growth.
  4. Going forward, we believe that China will continue to display the highest standard deviation in the world, owing to unforecastable political developments, which would constrain valuation multiples. We would thus refrain from investing in a broad MSCI China ETF, opting instead for stock picking or more targeted ETFs.

Return analysis


China: To invest or not to invest?

Short Term

– Seeking a more equal society by reducing inequalities: this could boost mass consumption

– Loosening recent tightening measures around the economy to inject liquidity into the economy (RRR cuts, etc.)

– A tactical, rather than secular, regulatory crackdown that could be short lived

– It is now close to consensus to be underweight Chinese equities.


– Opaque political decision making

– A decisive turn against private enterprises through multiple regulatory crackdowns targeting the education, real estate, healthcare & technology sectors: this could stifle innovation

– Xi Jinping’s unabated thirst for political, economic & social control could lead to a series of miscalculations (capital flights, economic lethargy, decoupling).

Long Term: in China, follow the CCP; in the US, follow the money

– Large & growing consumer market

– Strong & Sustainable real GDP growth > 4%: economically successful

– A dominant global trading partner: China became the EU’s top partner in 2020, ahead of the US (5% higher trade balance: $586Bil vs. $555Bil): this is critical to its geopolitical power

– Assuming economic decoupling, China could be a source of diversification (and also volatility) relative to US-centric global equity markets

– Invest domestically in line with CCP’s goals and priorities, and globally in companies used by the CCP to advance their goals. For example, many in corporate America (Apple, Goldman Sachs, Morgan Stanley, Blackrock, Bridgestone, Nike, to name a few) are discreet but formidable allies of China in the US.


– An increasingly authoritarian President Xi could become dangerously overconfident and underestimate its adversaries’ response

– A perilous imbalance, as the world increasingly relies on China for its prosperity and on the US for its security (in peacetime, the former is more significant)

– An insular mindset: potential decoupling from the US & other foreign partners would weaken the vitality of China’s economy

– Potential military takeover of Taiwan would inject significant geopolitical & economic risks in global equity markets: this would be a game changer

– Ambiguous and evolving long term economic goals makes stock picking treacherous

– Exclusive focus on domestic consumers, irrespective of foreign investors’ interests.

China’s best geopolitical weapon: trade


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