Until I looked, I would probably have said Wall Street. It’s human nature to over-weight recent data and, as last week’s new all-time high for the Dow Jones index confirmed, the US has led the pack since the financial crisis. When I conducted a quick straw poll of my colleagues, however, half of them opted for Shanghai. China’s economy has been transformed over the past couple of decades, it’s not unreasonable to assume that this might be reflected in the performance of its stock market.
The answer is more intriguing. The Dow Jones Industrials and the Shanghai A Share index have risen by almost exactly the same amount since 1997. Broadly, they have both trebled in value, they have taken a rather different path to get there. The US benchmark may have felt like a roller-coaster ride through the last 20 years’ booms and busts. But compared with China’s gyrations, it has been a pretty sedate journey.
Plenty has been written about the outlook for the US stock market in recent days. With the Dow adding 1,000 points in a little over three weeks, comparisons have inevitably been made with 1999 when it last rose at this kind of pace. The unseemly scramble for shares in Snapchat (a loss-making technology stock with few barriers to entry) has raised inevitable questions about the sustainability of the current rally. The US market is one of the world’s most highly-valued and its bull market is looking increasingly disconnected from fundamentals.
But what about China? In the headlines this time last year for all the wrong reasons, the country has been off investors’ radars ever since. Beijing is back in the spotlight this week, however, as the annual National Congress wields its rubber stamp in the Great Hall of the People. Top of the agenda this year is the state of the economy, with Premier Li Keqiang’s annual report confirming that Chinese growth is bumping along at the lowest rates for a generation, albeit at a level above 6pc a year that we can only dream of in the developed world.
China’s growth slow-down has been one reason why investors have lost interest in its stock market. But there are plenty of other concerns too. First among these is an explosion in China’s debts from 147pc of GDP ten years ago to 279pc today. China has kept its economic show on the road by throwing debt-fuelled investment at the state-owned industrial economy. It has a much greater reliance on investment and exports than countries such as Japan and Korea had at similar stages in their evolution. More recently, the threat of a more protectionist tone in global trade has raised the possibility that China might never escape the middle-income trap. The question remains: can China get rich before it gets old?
The historical evidence is against China making it to the ranks of the world’s high-income countries (a per capita GDP of more than $12,500, according to a new report on China’s prospects from Morgan Stanley). Only 19 countries have broken into the rich country club in the past 30 years of globalisation and only two of these (Poland and South Korea) have had populations of more than 20 million. It is not a given that a big poor country can become a big rich country.
For China to make that transition it will need to do a few things. First, it must manage down its debts over time to avoid the financial crisis that many fear. Doing that will require an acceptance of even lower rates of economic growth. Morgan Stanley thinks the current level of about 6.6pc will fall to 4.6pc on average. Second, it must manage its currency. Japan’s economy was scuppered by the surge in the value of the yen in the mid-1980s. China’s problem may be the reverse – a collapsing yuan as rising US interest rates and capital flight make it harder for Beijing to hold the line. It has already spent an estimated $1trn supporting the currency since 2014.
Third, the Chinese economy must shift towards a more mature balance between investment, exports and domestic consumption. The good news is that it is already making giant strides in this direction. It is the world’s largest market for a wide range of key consumer items, from cars to mobile phones. Private consumption could more than double from today’s $4.4trn by 2030. The transition from a manufacturing-driven economy to one focused on services must also be completed. Services represent 52pc of the Chinese economy today while in the developed world the ratio is closer to two-thirds.
Fourth, China must reform its state-owned enterprises. These mainly old-economy industries in China’s northern rust-belt produce low returns on investment, have high levels of debt and still dominate the economy in a way that is no longer the case in less centrally-planned emerging countries.
None of this will be easy and investors’ scepticism is understandable. But if China can break out of its middle-income trap and become rich before the demographic consequences of its now-abandoned one-child policy really kick in, its potential remains enormous. Its move towards high-income status will create opportunities and challenges for investors in two key ways.
First, the growth of a high-consuming middle-class will see massive growth in sectors like travel and tourism, healthcare and leisure both within China and elsewhere – on a recent visit to Japan, I was struck by the dominance of Chinese tourists at the main sites in Kyoto, for example. Second, China’s move into high-end manufacturing will provide both opportunities but also threats to the countries that currently dominate these – Japan, Korea, Taiwan and Germany.
China’s stock market may have settled for a score-draw with the US over the past 20 years. Out of favour and far cheaper than Wall Street, I wouldn’t bet against it over the next two decades.