Article

Why Chinese shares fail to reflect its economic growth

China’s economy has seen strong growth, but its stock market has underperformed for many years. Why is there this disconnect?

| 7 min read

In October 2007, the Shanghai Index of Chinese shares hit a high of 5,955. Today, after 14 years of strong growth, it sits at 3,541 – some 40% below its past peak. It managed to get back up to 5,166 in the summer of 2016, only to collapse again when the authorities took exception to many Chinese people buying shares themselves, often on borrowed money. The broker accounts and loans were squeezed to get shares back to lower levels.

Most explanations of share-price movements rest on growth. Conventional theory says that, as shares collectively provide exposure to rising turnover and profits as an economy grows, so over time you expect shares to move at least in line with real growth in the economy. They often do better than that thanks to the gearing of profits through company borrowings, and to the orientation of stock market values to faster-growing parts of the economy. Market indices back and run winners. So how come China still languishes so far below 2007?

Chart 1: Shanghai Composite index value over GDP growth rates since 2007

Extraordinary economic growth

Since that date, the Chinese economy had four years of growing at around 10% per annum, four years of growing at more than 7% a year and four years of growth of more than 6%. Even in the 2020 Covid year, the economy managed to grow a bit, despite the damage done by a long and severe lockdown. These were great numbers by world standards and would normally have led to good share performance. We now know that China grew by another 8.1% in 2021, catching up some lost growth in the first pandemic year.

Chinese history over the last century is all about of the rise of the communist party to power and its long unchallenged period in government.

The starting point of the Index in 2007 was high based on an easy money run up. The index also did not capture all the new areas of the economy on the scale the US index caught the digital revolution. We also need to include the way the Chinese state evolved, to a position where it is relatively hostile to private-sector enterprise in general and to successful entrepreneurs. It also grew a lot on the back of excessive property-based borrowings which are now being reined in by the government. Many Chinese bought property rather than shares.

Chart 2: Hang Sen index (Hong Kong) and select major tech stocks performance since January 2021


Chinese history over the last century is all about of the rise of the communist party to power and its long unchallenged period in government. Restated by President Xi in its centenary last year, the two great figures were Chairman Mao and reformer Deng. Deng made the growth of the private sector, the rise in living standards and the rise of the stock market possible after the famines and economic errors of Mao.

President Xi positions himself as the third great figure of the communist era and is tilting things back to Mao. He is proud to be called a Marxist and sees himself as the world champion of an alternative way to western free enterprise and democracy. He stresses nationalist themes as he seeks to impose a sovereign will on One China, which includes Hong Kong and Macao, and he thinks should also include Taiwan. He wishes to level down the rich whilst levelling up the poor. He will brook no rival, no alternative view, no possible well-heeled source of dissent.

Draconian Covid-19 restrictions

China is currently seeking to eliminate the virus again ahead of the winter Olympics in Beijing. Whole cities like Xi’an and Zhengzhou were locked down as soon as there are a few cases of Covid-19. A recent social media posting went viral as a woman told how she had been locked down in the flat of a man she had met on a blind date, illustrating the lack of flexibility in the enforcement of the Covid imperatives.

The authorities are carefully unpicking the excessive debts of some property companies.

Chinese general inflation has subsided and Chinese monetary policy is under decent control. The authorities are carefully unpicking the excessive debts of some property companies. The state is transferring more activity and assets to nationalised industries. It intends overseas lenders to take the financial hits and discourages entrepreneurs and large companies from using international markets and ventures.

The Olympics matter to China, but they will be sterile and heavily policed. They will not allow an international audience to turn up and watch in person and will control athletes very tightly to avoid contact with the local population.

Chart 3: CPI, Money Supply growth, and domestic credit to private sector as % of GDP since 2007

The new aggression towards the west will make it more difficult for China to steal or acquire western technology.

Are Chinese shares good value?

Some in markets think current levels offer a great buying opportunity. It is true China will grow faster than many countries this year, will avoid a major inflation problem and will have some company success stories. It is also the case that the authorities will not wish to stimulate its economy too much to bloat debts again and will continue to favour state over private enterprises.

In its latest move, the Peoples Bank of China has shaved some interest rates by 10 basis points and injected more liquidity into the banking system. So far, it seems the aim is to prevent undue banking stress and to avoid an economic downturn, but not to create a new bubble with a big expansion of credit.

In the longer term, the new aggression towards the west will make it more difficult for China to steal or acquire western technology, whilst creating a less than helpful environment for innovators at home. Maybe the stock market has got it right.

Meanwhile, rolling lockdowns means some continuing supply interruptions for the west, still very dependent on Chinese goods imports. There may be trading opportunities to enjoy some recovery in shares based on periods of monetary easing, but the direction of travel is towards a more state-dominated economy where foreign investors are not high up the list of priorities.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Why Chinese shares fail to reflect its economic growth

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