China: Yesterday's Story or More Compelling Than Ever?

Eric C. Moffett, Portfolio Manager, Asia Opportunities Equity Strategy

Executive Summary

  • China currently finds itself at an uncomfortable juncture, troubled by slowing growth and elevated debt and locked in an ongoing trade dispute with the U.S.
  • While headwinds clearly exist, China continues to provide compelling investment opportunities, in our view. Equity market inefficiency and low valuation levels give us good reason to be upbeat.
  • China A-shares represent a deep opportunity set with many attractive companies, a number of which remain undiscovered by foreign investors.

Faced with slowing economic growth, protectionist trade policies, and an uncomfortably high debt burden, some are suggesting that China is at risk of becoming “yesterday’s economic success story.” This raises questions about what the future holds for China and, similarly, for investors in China.


The macro outlook in China continues to dominate investor thinking, with concerns laser-focused on the country’s slowing economic growth. China’s economy is currently growing at a little over 6% p.a. While it has decelerated from the double-digit growth of a decade ago—levels unlikely to be seen again—it is still solid from a global standpoint.

However, what matters most for many domestic stocks is not so much national GDP growth, but the GDP growth of households. Here, data shows that disposable household income has increased significantly over the past 10 years, despite the slowing economy (Figure 1). There are two reasons for this: demographics and policy. In terms of demographics, the pool of working age people in China has been stagnant for some years, but spending by this group continues to grow. China factory owners, for example, are contending with progressively higher wages every year, to attract, and then keep, new recruits.

Figure 1: China’s Household Income Continues to Rise

As of December 31, 2017

Sources: Haver, China National Bureau of Statistics, OECD.

On the policy side, the government has made a priority of delivering meaningful wage increases every year over the past decade, across every province in China. The approach is not popular with businesses, but the government’s aim is to deliver more money into the hands of minimum wage earners and thereby help to underwrite a consumption boom.

Opening Quote [It] remains an ongoing misconception that China’s economy is dependent on exports. Indeed, net exports accounted for only around 2% of total GDP last year. Closing Quote

The income growth contributes to improved affordability for working-class families across a range of consumables, including holidays, insurance, health care, and medical services. And this increased spending is exactly what is happening across a demographic of hundreds of millions of people.


The China/U.S. trade war remains a key concern for investors in China, and prospects of improvement appear slim, certainly for the remainder of the Trump administration. Over the last six months, the narrative from the U.S. has shifted markedly. Originally simply seeking a better deal, and being apparently open to negotiation, the U.S. has more recently taken a harder line, notably extending sanctions to the “China 2025” industries, i.e., the high-tech sectors at the heart of China’s plans to become a developed, self-sufficient country.

It is highly unlikely that China will want to be subordinate to a western power intent on containing its modernization progress. It may well be hoping that the Trump presidency lasts only one term and, thus, be prepared to wait. However, in the meantime, there appears little scope for the current trade tensions to ease.

Despite this, it remains an ongoing misconception that China’s economy is dependent on exports. Indeed, net exports accounted for only around 2% of total GDP last year. This is largely because the “value‑add” in China is surprisingly quite low. The iPhone1 is a great example of this. While the phones are manufactured in China, only about 4% of the value-add happens there. Most of the components come from elsewhere, and the profit is largely captured by Apple in California.

Significantly, China trades far more with other emerging market countries than it does with the G3 (Europe, Japan, and the U.S.). As such, the U.S. has less leverage today than it did 15 years ago when trade was heavily weighted to the G3. This mitigates the pressure on China to react. The Chinese government also has numerous levers at its disposal, such as industry subsidies and tax rebates, to help soften the impact of trade tariffs.


Investors also see China’s substantial debt stockpile as a primary risk. It is true that, over the past 10 years, nonfinancial corporate debt to GDP in China has risen from 100% to 165%, with some commentators nervous that this level is simply unsustainable. However, it is crucial to keep in mind that interest rates in China have plummeted over the same period. Ten years ago, the corporate borrowing rate was in double digits. Today, it is between 4% and 5%. Corporate interest relative to GDP, which is the key systemic risk indicator, is currently at 7%, the same level it was 10 years ago.

As the rate cycle turns, China is likely to feel the stress but, unlike some other major markets, there is no pressure to raise rates anytime soon. There are no signs of inflation currently, and the impact of tariffs is likely be deflationary. All of which suggests that the level of debt is not yet a major concern.


While Chinese equities have underperformed all other major markets, year-to-date, in 2018,2 there is a lot to be excited about in this market. Valuations look very cheap, which is partly a reflection of the slowing growth/trade sanctions headwinds. However, a quick comparison shows the MSCI World Index3 is currently trading at a price/earnings ratio of nearly 20 times, well above the China A-shares market at 12 times earnings. This represents crisis-level valuations for an economy that is still growing faster than most places in the world.

In the 15 years that I have been investing in emerging markets, I have never seen greater inefficiencies than I see in the China A-share market today. This is partly due to it being a very deep market. There are a lot of very good companies, but many remain hidden from the gaze of foreign investors. As a retail-driven market, information is not often published in English, nor are investor roadshows a feature of corporate activity, meaning that only a small percentage of the market is owned by foreign investors (Figure 2). This represents a great environment for finding mis-priced opportunities.

Figure 2: China A-Shares Represent a Huge Opportunity Set to Explore

As of June 30, 2018

Source: BofAML.

Of course, poor quality companies in the A-shares market are present, particularly down the market cap spectrum. However, it is possible to find blue chip companies, growing by around 15% a year, at very reasonable valuations. This level of growth may be less attractive to local investors, but for the astute investor these are quality companies, with sound balance sheets and good dividend profiles.


This is another misconception that no longer describes modern China. As wages have risen, China has become less competitive and has moved out of a range of manufacturing areas. Much of the manufacturing capacity concentrated in Southern China, for example, has been either closed or moved away. China is now moving up the value chain, with a growing amount spent on research and development (R&D) in high-tech areas like artificial intelligence. R&D expenditure has risen to OECD levels of 2%–2.5% of GDP.

Opening Quote The China A-shares market is trading at 12 times earnings. This represents crisis-level valuations for an economy that is still growing faster than most places in the world. Closing Quote

Electronic payments is one area that China is making great strides in terms of innovation and progressing up the value chain. Few people in Beijing or Shanghai now carry cash, with mobile devices the preferred mode of payment, via service providers like Alipay and Tenpay. China has effectively skipped the credit card phenomenon and gone straight to electronic payment processing. As a result, the progress in this area is well beyond many major markets, including the U.S. This represents a powerful trend that can be directly accessed by investing in the parent Internet companies of these service providers, such as Alibaba Group and Tencent Holdings.

When it comes to applying new technologies, China is a fertile testing ground, as new ideas and products can be rolled out to millions of people in a relatively short time. Good ideas quickly stand out and are widely adopted, while the bad ideas disappear just as quickly.


I continue to believe that growth in China is still strong. And if you look at household GDP growth, it is still very strong. Meanwhile, from a market perspective, valuations are not only undemanding, they are currently at crisis levels where the domestic A-shares market is concerned. That is not to say that they can’t go lower still, but when I look at the Chinese A-share market today, I see some of the greatest inefficiency I’ve ever seen.

1The trademark displayed is the property of its respective owner. T. Rowe Price is not endorsed, sponsored, or otherwise authorized by or affiliated with the trademark owner represented by the trademark displayed herein.

2Source: FactSet, as of October 20, 2018.

3Source: MSCI, as of October 20, 2018.

Copyright 2018 FactSet. All Rights Reserved.

The specific securities identified and described above do not necessarily represent securities purchased, sold or recommended by T. Rowe Price.  This information is not intended to be a recommendation to take any particular investment action and is subject to change.  No assumptions should be made that the securities identified and discussed above were or will be profitable.

Important Information

This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. 

It is not intended for distribution to retail investors in any jurisdiction.

Australia—Issued in Australia by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 50, Governor Phillip Tower, 1 Farrer Place, Suite 50B, Sydney, NSW 2000, Australia. For Wholesale Clients only.

Canada—Issued in Canada by T. Rowe Price (Canada), Inc. T. Rowe Price (Canada), Inc.’s investment management services are only available to Accredited Investors as defined under National Instrument 45-106. T. Rowe Price (Canada), Inc. enters into written delegation agreements with affiliates to provide investment management services.

DIFC—Issued in the Dubai International Financial Centre by T. Rowe Price International Ltd. This material is communicated on behalf of T. Rowe Price International Ltd. by its representative office which is regulated by the Dubai Financial Services Authority. For Professional Clients only.

EEA—Issued in the European Economic Area by T. Rowe Price International Ltd, 60 Queen Victoria Street, London EC4N 4TZ which is authorised and regulated by the UK Financial Conduct Authority. For Professional Clients only.

Hong Kong—Issued in Hong Kong by T. Rowe Price Hong Kong Limited, 21/F, Jardine House, 1 Connaught Place, Central, Hong Kong. T. Rowe Price Hong Kong Limited is licensed and regulated by the Securities & Futures Commission. For Professional Investors only.

New Zealand—Issued in New Zealand by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 50, Governor Phillip Tower, 1 Farrer Place, Suite 50B, Sydney, NSW 2000, Australia. No Interests are offered to the public. Accordingly, the Interests may not, directly or indirectly, be offered, sold or delivered in New Zealand, nor may any offering document or advertisement in relation to any offer of the Interests be distributed in New Zealand, other than in circumstances where there is no contravention of the Financial Markets Conduct Act 2013.

Singapore—Issued in Singapore by T. Rowe Price Singapore Private Ltd., No. 501 Orchard Rd, #10-02 Wheelock Place, Singapore 238880. T. Rowe Price Singapore Private Ltd. is licensed and regulated by the Monetary Authority of Singapore. For Institutional and Accredited Investors only.

Switzerland—Issued in Switzerland by T. Rowe Price (Switzerland) GmbH, Talstrasse 65, 6th Floor, 8001 Zurich, Switzerland. For Qualified Investors only.

USA—Issued in the USA by T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange Commission. For Institutional Investors only.

© 2018 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.




Latest Date Range
Audience for the document: Share Class: Language of the document:
Download Cancel


Share Class: Language of the document:
Download Cancel
Sign in to manage subscriptions for products, insights and email updates.
Continue with sign in?
To complete sign in and be redirected to your registered country, please select continue. Select cancel to remain on the current site.
Continue Cancel
Once registered, you'll be able to start subscribing.

By clicking the Continue button, I acknowledge that I have read and accepted the Privacy Notice

Continue Back

Change Details

If you need to change your email address please contact us.
You are ready to start subscribing.
Get started by going to our products or insights section to follow what you're interested in.

Products Insights

GIPS® Information

T. Rowe Price ("TRP") claims compliance with the Global Investment Performance Standards (GIPS®). TRP has been independently verified for the twenty one- year period ended June 30, 2017 by KPMG LLP. The verification report is available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm's policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation.

TRP is a U.S. investment management firm with various investment advisers registered with the U.S. Securities and Exchange Commission, the U.K. Financial Conduct Authority, and other regulatory bodies in various countries and holds itself out as such to potential clients for GIPS purposes. TRP further defines itself under GIPS as a discretionary investment manager providing services primarily to institutional clients with regard to various mandates, which include U.S, international, and global strategies but excluding the services of the Private Asset Management group.

A complete list and description of all of the Firm's composites and/or a presentation that adheres to the GIPS® standards are available upon request. Additional information regarding the firm's policies and procedures for calculating and reporting performance results is available upon request

Other Literature

You have successfully subscribed.

Notify me by email when
regular data and commentary is available
exceptional commentary is available
new articles become available

Thank you for your continued interest