• The FTSE China H50 has underperformed U.S. stocks so far in 2021
  • Chinese stocks, on average, have modestly positive correlations with U.S. stocks
  • High corporate debt, widening credit spreads may have weighed on Chinese stocks
  • Higher raw materials costs may begin weighing on Chinese markets
  • China has much less government and household debt than the U.S. or Europe
  • Chinese stocks trade at about half the valuation ratios of their American counterparts

Since 2004, the FTSE China H50 Index has largely kept pace with the FTSE Emerging Markets Index as well as U.S. indices such as the S&P 500® and Russell 2000 (Figure 1). However, the pattern of returns has often been varied.  Chinese stocks, as measured by the FTSE’s Hong Kong dollar-denominated index, outperformed U.S. stocks during the high growth years leading up to the 2008 global financial crisis.  Between 2008 and 2015, Chinese shares largely underperformed their American counterparts before turning in a more-or-less similar performance from 2016 until early 2021.

Figure 1: Performance of various equity indices since 2004

So far this year, Chinese stocks have diverged again from the U.S. market, falling over 20% even as shares in the U.S. have continued to rise.  There appear to be several factors behind the divergence: 

  • China’s government has begun to vigorously enforce anti-trust laws with the idea of helping consumers and workers while promoting economic equality. 
  • China’s economy has begun to slow down, with both official GDP and alternative measures, such as the industry-focused Li Keqiang Index, showing growth rates coming down to around 5% (Figure 2).
  • Several large Chinese real estate firms have encountered financial difficulty leading to a sharp rise in high-yield corporate bond rising from 9% in July to over 20% by September and October. 
  • Prices for coal and natural gas have more than doubled this year, straining China’s electrical grids, with occasional power outages in certain provinces.  Higher coal and natural gas prices have hit Chinese firms harder than their American counterparts since Eurasian energy costs were higher than North American energy costs to begin with (Figure 3).
  • Although China’s population is now mostly vaccinated, COVID-19 outbreaks lead to occasional regional lockdowns and other measures to contain its spread.
  • Global supply lines remain under stress, and shipping costs from China to the U.S. are still 4x pre-pandemic levels.

Figure 2: Coal prices have risen by over 600% since May 2020

Figure 3: Recent rise in energy costs add to already high prices paid by Eurasian manufacturers

China’s economy also has many areas of strength including strong export growth amid a boom in global demand for manufactured goods.  Some of the strength in exports has been offset, however, by higher raw materials costs.  In addition to higher coal and natural gas prices, Chinese firms are encountering much higher prices for many metals including aluminum, copper, magnesium and steel.  Food prices have also risen.  Despite higher prices for raw materials, China’s inflation rate remains moderate (Figure 4).  This could give the Bank of China space to further ease monetary policy even as the Federal Reserve,  the Bank of England, and other central banks look toward tightening. 

Figure 4: Chinese inflation rate has come down substantially

Easier monetary policy might also weaken the Chinese currency (see our related article here).  Equity markets often outperform when currencies weaken as it gives firms whose costs are denominated in those currencies a competitive advantage.

China’s debt levels have risen from 140% of GDP to 280% since 2008.  However, Chinese government debt at 67% of GDP is much lower than that of peers such as the U.S. and eurozone where debt ratios exceed 100% of GDP.  The Chinese government’s pandemic-related fiscal stimulus came to around 3% of GDP, compared to 10-25% of GDP in many other nations.  As such, by comparison, the Chinese government has a great deal of scope to borrow, if necessary.  Moreover, it has an enormous pool of domestic savings to tap into as well.

Chinese households have high savings rates and relatively low debt compared to their American and European peers.  Low household debt could also prove positive for Chinese growth going forward: if individuals feel confident about lowering their savings rates or taking on additional consumer or mortgage credit, it could foster a boom in consumer spending that would reduce China’s reliance of exports and capital investment as drivers of growth.

Where China has truly exceptional levels of debt, however, is in the non-financial corporate sector.  Here debt levels total 160% of GDP, roughly twice the levels of Europe and the U.S. The combination of high corporate debt levels, slowing economic growth and the doubling of high yield corporate bond yields may have contributed to the under-performance of Chinese equities (Figure 5). 

Figure 5: China has low government and household debt but very high corporate debt

Short-term performance aside, international investors may find the diversification potential of Chinese stocks interesting. On average, over the past few decades, Chinese shares have had correlations with U.S. indices ranging from -0.45 to +0.95.  On average, the correlations have been around +0.4 (Figure 6). 

Figure 6: Chinese equities show a modest correlation with other markets.

The divergence of Chinese and U.S. markets has left the markets with very different valuations levels.  The FSTE China 50 trades at 11.76x the consensus 2022 earnings estimate, around half the level of the U.S. equity market (22.2x for the S&P 500 and 33.2x for the Russell 2000).  Moreover, Chinese stocks pay significantly higher dividend yields than their American counterparts (2.27% for the FTSE China (H)50 compared to 1.3% on the S&P 500 and 1.07% on the Russell 2000). 

Part of the difference in valuation derives from diverging sector weights.  U.S. equities are heavily weighted towards technology stocks whereas Chinese stocks are heavily weighted towards financial services and consumer stocks (Figure 7).  The differences in valuation levels, along with the diverging sector weights, economic challenges, and monetary policies, could lead U.S. and Chinese equity markets down diverging paths in the future.

Figure 7

Industry Sector FTSE Emerging Markets FSTE China (H)50  Russell 2000 S&P 500®
Technology 25.46% 3.17% 12.10% 27.78%
Telecommunications 3.75% 1.76% 1.95% 11.17%
Health Care 4.49% 7.10% 20.58% 13.03%
Financials 19.37% 37.41% 14.63% 11.09%
Real Estate 2.77% 2.64% 6.98% 2.64%
Consumer Discretionary 16.14% 10.77% 15.26% 12.29%
Consumer Staples 5.75% 28.12% 2.98% 5.86%
Industrials 6.17% 3.39% 14.53% 8.45%
Basic Materials 7.22% 3.56% 3.65% 2.56%
Energy 6.44% 1.54% 4.59% 2.62%
Utilities 2.44% 1.10% 2.73% 2.50%

Source: FTSE Russell, Bloomberg Professional (IMAP for SPX)

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