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By Michael Mooney, Financial Advisor
China’s boom was once seen as a way to add growth exposure to a portfolio.
Investing in China, emerging markets or international stocks, comes with additional risks.
How do I avoid some of this extra risk exposure? International exposure with US stocks can be achieved. And your portfolio can be impacted positively overall, by international growth.
LOOK BACK: What are the major events that have contributed to China’s rise and fall?
1. Rapid Growth Phase (2008-2015):
Following the global financial crisis, China was on an upward trajectory. Between 2009 and 2014, China’s economy grew by an average of 8.8% annually. Their economy overtook Japan as the world’s second largest in 2010 and many economists speculated when, not if, they would overtake the US as the largest economy in the world.
China’s stock market initially recovered from the financial crisis quicker and faster than the US. As measured by the MSCI China Total Return Index, China’s markets had grown over 270% from its lows in late October 2008 to its high in April 2015. Its economy was growing at breakneck speed, largely driven by government investments in infrastructure, urbanization, and a booming manufacturing sector.
The below, graph shows China's outperformance against US and global market indices following the 2008 financial crisis.
2. Stock Market Crash (2015)
While the MSCI China Total Return Index had nearly quadrupled in the six-plus years following the global financial crisis, the pace of growth was unsustainable.
Much of the rise was attributed to margin trading, speculation, and government promotion through state-run media, rather than actual earnings growth. It all came crashing down later in 2015.
By the end of the year, China’s markets had dropped by nearly a third. The Chinese government intervened with measures such as lowering interest rates, halting initial public offerings (IPOs), and implementing stock purchase programs, but the market remained unstable.
3. Slowing Growth and Trade War with the United States (2015-2019)
Post-crash, high levels of debt and lower growth kept foreign investors away. The government aimed to transition from an investment-driven economy to one driven by consumption and services.
However, China’s economy slowed to a growth rate of 6.9% in 2015, a 25-year low (in comparison, the US economy grew by 2.7% in 2015). The economy continued to show slow growth, with GDP hovering between 6% and 7% annually (2016 -2019).
During much of the same period, the U.S.-China trade war also significantly impacted China's economy. Under President Donald Trump, the US sought to protect American companies and consumers by implementing tariffs and trade barriers. China was specifically targeted based on previous unfair trade practices and intellectual property theft. Tariffs eventually affected 93% of products exported from China to the US by 2019. In turn, the trade war had a material negative impact on China’s economy and employment.
4. COVID-19 Pandemic (2020)
The COVID-19 Pandemic, and related government policies, severely impacted China’s economy. Initial lockdowns caused a sharp economic contraction in 2020.
Early on, it did appear that China’s initial strategy had worked and was a model for the rest of the world to follow. It appeared that hospitalizations and deaths from the virus had tapered off, and their economy and stock market held up comparatively well in 2020. China’s technology sector led the way, with a return of nearly 70% on the year, compared to 45% for the NASDAQ Composite during the same year.
While it initially appeared that China came out of the crisis relatively unscathed compared to other major economies, such as the US and Europe, China’s “zero-COVID” strategy between 2021 and 2022 had a harsh impact on its economy. This policy, implemented in an attempt to limit any transmission of the virus created rolling lockdowns, halted manufacturing and disrupted supply chains through 2022.
Between 2020 and 2023, China’s economy grew at an average rate of just 4% annually, compared to the previous decade's (2010-2019) average GDP growth of 7%.
5. Scandals, Real Estate and Debt Crisis (2020-Present)
Cracks began to develop in China’s market in 2020, when a prominent China-based coffee operator was penalized for inflating sales figures. Despite the scandal, China’s stock market continued to rise until early 2021. Regardless, investors began to be more and more skeptical of Chinese stocks due to light regulation and soft bookkeeping.
The real estate sector, a crucial component of China’s economy, has also been under immense pressure over the past years. The highly publicized debt crisis of property giant Evergrande in 2021 highlighted the broader issue of excessive borrowing and unsustainable growth in the real estate market. This crisis has led to a downturn in property values and rising concerns about China's financial stability. This pressure has been a factor in China’s stock market, which has performed poorly over the past several years. Conversely, the US market has taken a completely different route and has continued its upward trajectory over the past several years.
While it once appeared that China’s economy could surpass the US within a decade, it now is questionable whether that will happen at all. China’s population growth has slowed dramatically due to the one-child policy, and China was recently surpassed by India as the world’s most populated country.
YOUR GAME-CHANGING QUESTION ANSWERED: How do I avoid some of this extra risk exposure with China's questionable performance?
China’s stock market has been plagued by slowing growth, negative policy, and scandals over the last several years. While investing in Chinese stocks once looked like a terrific opportunity in your portfolio, it appears quite the opposite right now.
On top of that, the regulatory risk of investing in companies inside of China is real – given the scandals. Are the reported numbers accurate?
It is hard to tell…
International stocks in general, including China, carry certain risks to investors that may not always be associated with domestic stocks.
These risks would include:
Regulatory: Countries have different regulations and legal systems that can impact businesses. Additionally, sudden changes in regulations, tax policy, or trade agreements can affect profitability.
Currency: Fluctuations in currency exchange rates can impact the value of your investments.
Geopolitical: Trade tensions and political issues can impact stock performance and market stability.
Transparency: It may be more challenging to obtain reliable and timely information about foreign companies.
While we can completely avoid investing in Chinese-listed stocks, or any other country in which we deem that the risks outweigh the potential benefits, it is hard to avoid China’s impact on the global economy. This has an impact on any company that currently does or plans to do business in China, regardless of where they are headquartered. Many American companies have manufacturing facilities in China, rely on product components made in China, or a significant portion of their sales come from China.
However, the risks associated above – regulatory, geopolitical, etc. – would typically be lower for a company that has a factory in China or has 5% of sales coming from China; rather than a company headquartered in China.
The simple way to mitigate the risks of investing in China, emerging markets or international stocks (in general) is to avoid them.
Even though the S&P 500 and US market have outperformed international stocks over the past decade, it will likely not always be the case. We need to find ways to provide country diversification-while at the same time mitigating some of the risks mentioned, above.
This can be achieved with the following:
Diversification: By company, country, and region, we minimize some of the risks. By having minimal concentration in these areas, we aim to reduce the risk that one currency, one government or one policy can have on your entire portfolio.
Focus on Investment Plan and Long Term Goals: The amount of risk in your portfolio should be determined by your investment goals and investment plan. If you are many years from retirement or your spending goals, you may be able to take on more risk to achieve potential rewards possibly, versus someone who is nearing or in retirement.
Invest in US Based Companies to Gain International Exposure: It is possible to gain international sales and revenue exposure without taking on some of the extra risks for companies that have overseas headquarters. Plenty of US-based companies have a large percentage of revenue and profits from overseas, and will benefit if sales internationally increase over domestically. At the same time, the accounting and reporting regulations that these companies must abide by are stringent (within the US).
*Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.
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2024 Forbes Best-in-State Wealth Management Teams: Awarded January 2024; Data compiled by SHOOK Research LLC based on the time-period from 3/31/22 - 3/31/23 (Source: Forbes.com).
The Forbes Best-in-State Wealth Management Teams rating algorithm is based on the previous year’s industry experience, interviews, compliance records, assets under management, revenue and other criteria by SHOOK Research, LLC. Investment performance is not a criterion. Self-completed survey was used for rating. This rating is not related to the quality of the investment advice and based solely on the disclosed criteria.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock's weight in the Index proportionate to its market value.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market