The headquarters of Chinese AI startup DeepSeek in Hangzhou in China’s Zhejiang province on Jan. 14. Observers say China is right on the heels of U.S. innovators in key areas such as artificial intelligence.JADE GAO/AFP/Getty Images
Mark Carney is busily resetting Canada’s stance toward China. You might want to do the same with yours.
The Asian giant looms as one of the biggest potential sources of rewards for investors over the next couple of decades. It is also one of the bigger risks. Like it or not, your portfolio will be affected by what happens in Beijing.
For Canadian investors, the challenge is deciding how much – if anything – to bet on Chinese stocks. It is not an easy call.
Optimists will see a lot to like, starting with the prices. Chinese equities are amazingly cheap compared with those in the United States or Canada. They sell at valuations roughly 40 per cent lower than their U.S. counterparts.
Yet China is not some unsophisticated developing country: It dominates global manufacturing and it leads the world when it comes to growth industries such as batteries, electric vehicles and solar power. By investing in its companies, you are buying a stake in what is shaping up as the No. 1 or No. 2 economy of the 21st century.
The problem is that there are nearly certain to be major bumps along the way. Two issues in particular should restrain your enthusiasm.
The first is politics. China’s leadership has a history of violent swerves. Remember its one-child policy? Or its draconian pandemic lockdowns? Both were simplistic responses to complex problems. Both inflicted immense pain on Chinese citizens before they were reversed.
Investors shouldn’t think they are exempt from such U-turns. Chinese President Xi Jinping’s vicious crackdown on some of his country’s tech leaders in 2020 demonstrated that Beijing won’t hesitate to hammer shareholders in pursuit of political goals. While Beijing’s assault on its big online players seems to be fading, there is no guarantee that similar incidents won’t reoccur.
The second issue with Chinese stocks is past performance. Despite China’s warp-speed economic growth, the country’s stock markets have produced generally dismal results.
Over the past decade, a Canadian investor in iShares China Index ETF XCH-T made a grand total of 2.8 per cent a year while enduring heart-stopping volatility. The lacklustre results reflected Beijing’s ham-handed approach to handling its real estate bubble. They also reflected the Chinese politburo’s fondness for encouraging cutthroat competition among a host of domestic rivals. This approach stimulates innovation and efficiency, but it leaves companies with little profit with which to reward shareholders.
So what to do? Despite the perils, I think there is a growing case for leaning in the direction of China as well as emerging markets more generally. No, you don’t want to bet your retirement on Chinese equities, but allocating 5 to 10 per cent of your portfolio to a bet on China and related South Asian countries seems like an intelligent way to diversify your risks.
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Most notably, a bet on China can help offset the increasing risks in the U.S. market. U.S. President Donald Trump’s on-again, off-again obsession with taking over Greenland this past week demonstrated what can go wrong when a reality-TV star gets a powerful country to run.
Under his leadership, abrupt policy swerves have become just as common in Washington as they ever were in Beijing. The Ego-in-Chief has already torched the previous administration’s clean energy initiatives, picked fights with long-time allies and trashed central bank independence. Does anyone care to bet on what craziness he will come up with next?
China looks positively sedate in comparison. Mr. Xi is intent on building an industrial powerhouse that will dominate pivotal sectors of the 21st-century economy.
A key part of his strategy is to make China a global leader in science and engineering. The Critical and Emerging Technologies Index from the Harvard Kennedy School shows the U.S. still leads the world in five crucial research areas – artificial intelligence, quantum computing, computer chip design, biotech and space science. However, China is now second in each of those fields, well ahead of Canada, Japan and European nations.
Beijing will not be content to remain No. 2 forever. It is pouring money into research and development and it is clearly gunning for top spot. While it still may lag the U.S. in some leading-edge technologies, it is “incredible that a developing nation is now seemingly technologically ahead of the collective might of Europe, bests Japan, and finds itself miles beyond every other developed nation on the planet,” writes Eric Lascelles, chief economist at RBC Global Asset Management.
Other observers agree that China is right on the heels of the U.S. innovators in key areas such as artificial intelligence. “China’s AI development over recent years has been staggering,” writes Leah Fahy, China economist at Capital Economics.
“At the start of 2024, cutting-edge U.S. models outperformed Chinese models 64 per cent of the time,” Ms. Fahy notes. “As of October last year, that had narrowed to 51 per cent – just shy of a coin toss. The launch of Google’s newest Gemini model means that, at the time of writing, the gap has widened again. But the big picture is that every time U.S. models advance, Chinese ones achieve similar performance within weeks or at most a few months.”
Investors may want to ponder this observation. Chinese stocks are far cheaper than their U.S. counterparts. They offer nearly as compelling a story when it comes to technology. Putting a small portion of your portfolio into an exchange-traded fund that tracks China – or even emerging markets in general – seems like a good way to hedge against a changing world order.