Chinese Equities: Value Play or Value Trap?
Here's what you need to know before investing in China's Stock Market...
Hi, Investor 👋
I’m Jimmy, and welcome to another edition of our newsletter. Today, we’re taking a closer look at Chinese equities - a market full of potential, but also packed with risk.
Before you invest a dollar in China, this is what you need to know. As always, feel free to pass this along to any investor weighing their exposure to China.
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Over the past two decades, China has often been described as the growth story of the 21st century - and for good reason.
A population of over 1.4 billion, breakneck infrastructure development, rapid tech adoption, and global trade dominance have propelled the country to become the world’s second-largest economy.
On paper, investing in Chinese stocks seems like a no-brainer…
But if you’re considering putting capital into Chinese equities today, take a moment. It’s a more complicated story than many headlines suggest.
Why Investors Are Drawn to China?
Let’s start with the upside.
China is still growing - even at a moderated pace, its GDP is expanding faster than most developed nations. It’s a global leader in sectors like e-commerce, electric vehicles, and fintech. Its middle class is large, aspirational, and increasingly digital.
And while Western economies are battling aging demographics, China still has room for urbanization, productivity gains, and catch-up growth - especially inland. Add to this a low market valuation compared to the U.S., and many investors see a buying opportunity.
Plus, the government recently introduced a stimulus package to prevent further economic slide. Markets initially responded positively, with Chinese indices rallying in one of their strongest 10-day moves ever.
So, what’s the problem?
The Counterpoints: Why Caution Is Warranted
That rally? It didn’t last.
Despite bold headlines, the stimulus wasn’t the “big bazooka” markets hoped for. It was modest in scale - a lifeline, not a growth engine. The goal wasn’t to kick-start the economy, but to stabilize over-leveraged local governments and prevent a financial crisis.
What followed was a quick reversal. Investors sold into strength. Sentiment cooled. The bounce faded.
The deeper issue is this: Chinese equities haven’t just underperformed recently -they’ve trailed global markets for over a decade.
Since 2012, the MSCI China Index has underperformed the U.S. equivalent by nearly 70%. That’s not just due to geopolitics or trade - it's because earnings growth has been weak.
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The Real Disconnect: GDP vs. Earnings
China’s economy keeps growing, but that growth isn’t showing up in corporate earnings.
Since 2012, the relationship between GDP and EPS (earnings per share) has broken down…
Unlike in most economies, growth in China hasn’t translated to shareholder returns.
Why?
The core issue is capital allocation. Chinese firms - especially state-linked ones - are not deploying capital efficiently. A decade ago, China’s return on equity (ROE) was higher than that of U.S. companies. Today, it’s significantly lower.
Less efficient markets deserve lower valuations - and that’s exactly what we’ve seen.
The Property Problem:
China’s real estate sector has long been a pillar of growth - and now, it’s a source of instability…
Property sales are down sharply. Investment is contracting. Prices are falling. Yet many unsold homes remain, keeping prices artificially high.
This is part of a broader balance sheet recession - a term used to describe when over-indebtedness stifles demand. It’s not a typical business cycle. It’s structural. And it takes years, even decades, to resolve.
Sound familiar? Japan faced something similar in the 1990s. Policymakers delayed tough decisions, and the result was a lost decade (or two). There are clear parallels with China today.
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Local Government Debt: A Silent Crisis
Local governments in China are deeply in debt. They borrowed aggressively during the boom years, often relying on land sales for revenue. With the property downturn, that revenue stream has dried up.
Now, most Chinese government debt is held by local entities that lack the resources to repay it. And much of it is tied to the same shaky real estate market.
This debt overhang limits the effectiveness of stimulus. You can’t spend your way out of a recession if your hands are tied by structural imbalances.
Geopolitical and Regulatory Risks
Beyond economics, there’s policy risk.
Over the past decade, the Chinese government has tightened its grip on private enterprise. From tech giants to tutoring companies, crackdowns have been swift and unpredictable. The state is now more involved in capital allocation than at any time since the pre-reform era.
And relations with the West remain strained. Trade restrictions, semiconductor bans, and rising protectionism create additional pressure.
Put simply, Chinese companies face not just market risk - but regime risk.
In the past decade, China’s government VC funds have invested $912 billion, with yearly investments comparable to the annual spending on all U.S. government industrial policies during the same period.
Researchers analyzed 1,863 Chinese government VC funds, 6,514 intermediaries, and 45,419 firms (2000-2023) using databases like Zero2IPO. Funding, mainly from budgets and SOEs, peaked in 2013-18 with 238 funds/year, but slowed to 115/year post-2019 amid economic and regulatory shifts…
Here is a chart that explains the breakdown of capital allocation by the Chinese government:
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So... Should You Avoid Chinese Equities Entirely?
Not necessarily.
There are still world-class companies in China. Some are deeply undervalued. Others are innovating in ways Western peers can’t match.
I can name a few of them, such as:
Alibaba ($BABA)
Pinduoduo ($PDD)
BYD ($BYDDY)
Tencent ($TCHY)
JD.com ($JD)
For long-term investors with a high risk tolerance, there could be opportunities - especially if reforms take hold.
But the market is not for the faint of heart. Until we see a decisive shift - a true “bazooka” stimulus or credible structural reform, caution is warranted.
Bottom Line:
China has incredible potential. But investors shouldn’t confuse potential with performance.
Yes, Chinese equities are cheap. Yes, the long-term story is compelling. But structural issues, policy uncertainty, and capital inefficiency remain major headwinds.
This is not a call to boycott China - it’s a call to go in with eyes wide open. Wait for policy clarity. Look for signs of earnings recovery.
And above all, stay selective.
Because in this market, value traps can look a lot like value plays.
Thank you for reading this far.
Until next time,
Jimmy
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Great piece, Jimmy, I've been reading the New China from Keyu Jin and certainly the Chinese stock market is far from growing steadily.
Going for these 'red chips' (why not 😆) seems a secure approach as far as we can expect regarding investments.
Don’t invest in china if you don’t understand its history culture and how the policymakers and leaders think
For me I’ve invested in china for many years now and that’s bc I’m very comfortable with what I know