The China Discount

It is becoming easier to argue that China could emerge as one of the main beneficiaries of today’s geopolitical disorder. While Washington is increasingly focused on conflict in the Middle East and tensions elsewhere, China’s export machine continues to power ahead. Its trade surplus is on course to exceed $1 trillion again this year, giving Beijing considerable economic leverage despite persistent problems at home.

Which raises an interesting question. If China is an economic and geopolitical superpower, why is its stock market worth so much less than America’s? China’s economy was worth roughly $19.5 trillion last year, compared with $30.8 trillion for the US. In other words, China’s economy is only around 37% smaller than America’s, yet Chinese companies account for just 2.5% of the MSCI All Country World Index, compared with nearly 64% for the US.

The reason is simple: an economy is not a stock market. America has a disproportionate number of highly profitable, globally dominant companies structured to generate returns for shareholders. China has much greater state involvement, more concentrated ownership and a financial system where national priorities can sit alongside shareholder returns.

Then there is trust. The property crisis, weak domestic demand, capital controls and periodic regulatory intervention have all made investors more wary of Chinese assets. That does not make China any less important. Quite the opposite. Its economic and geopolitical influence may continue to grow. However, the stock market is asking a different question: how much of that success will ultimately belong to shareholders?