China’s stock market hit a five-year low in February. As China celebrates new year, what’s gone wrong?

It’s not long since investing in China was the big new opportunity in investment markets.  Alongside the west coast of the US, it was a region of the world capable of building trillion-dollar tech firms.  It had a fast-growing economy, a dynamic workforce, and foreign capital was flowing in fast.  The skyline of every city in the world’s second-biggest economy was dominated by cranes in a construction boom.

Now China is battling a slow-motion property crisis, a sluggish economy, and a worsening investment climate.

Investors are heading for the exit, with over US $1 trillion of value being lost on China and Hong Kong stock exchanges this year (before rallying in mid-February on hopes of state support).

Restructuring China’s property market

First-up is a property crisis, which officials have been slow to address.  Property prices and sales volumes have been falling since 2022.  That – alongside debt in their businesses – has got property developers into trouble.  Developers are now defaulting on their debt.

But no Nama is currently riding to the rescue.  One major developer, China Evergrande, recently went into liquidation.

The property sector represents around a quarter of China’s economy. So this crisis in turn is hitting the wider economy.

Housebuilding is at a level last seen around two decades ago.  With over 200 million stock market investors in China, many domestic investors have lost money in the sector.

The economy has emerged weak from Covid

At the same time, the economy has been slow to bounce back from lengthy Covid restrictions.  The big tech companies that were the source of much investor excitement face regulatory scrutiny and a growing expectation that companies invest for social or government aims as well as shareholder value.

That trend has been going on for some time: four years ago Alibaba’s plans to IPO its Ant Financial business were scuppered in the wake of founder Jack Ma’s remarks criticizing regulators.

It all means that economic growth is around half of pre-Covid levels.  While the western world is battling inflation, China has the opposite problem: deflation.  The worry is that China could enter a Japan-style period in the economic doldrums.

Political expectations of business are changing

Western fund managers entered China with hopes of a dynamic economy, supportive of business. They now face a quite different environment.

There’s a rising expectation that wealth is redistributed more fairly, and also that businesses promote aims in line with the Chinese communist party, for example by building up critical industries to rival the US in semiconductors and artificial intelligence.

A prolonged anti-corruption drive has reduced western investors’ appetite to station staff in China.  And a ban earlier this month on “malicious” short-selling will impede fund managers further, as they will have difficulty hedging positions they take within their funds.

Internationally, tensions have also risen as the world economy deglobalizes, with economies like the US rewarding onshoring of industry.

Should you avoid investing in China?

What’s clear from a look at investing in China over the last five years is how fast things can change.  It’s true the outlook is tougher than it has been in recent years.  But China remains the world’s second-largest economy, and many of its weaknesses are also potential strengths.

For example, the fact that the state is so heavily involved in the economy gives it powers to effect change that are hard to imagine in freer economies.  Earlier this month, Chinese stocks enjoyed their largest gain in two years on hopes that officials are readying support package for markets.

That’s why for the balanced investor, it makes sense to have an element of exposure to China.  But taken as a whole, a lot needs to be resolved before China recovers its former excitement in the investment community.