ETFs and China’s back-to-the-future moment

Delorean carWhile no one can agree what the future of China’s economy looks like, one thing does seem clear: it’s having a back-to-the-future moment. As this article in Forbes puts it, some believe today’s China today looks like the U.S. after World War II as it builds the institutions that will transform it into the leader of the global economy in the decades to come. Others think China’s troubled banking sector makes it look more like the U.S. in 2008—I don’t need to tell you what happens next.

It’s worth noting how those divided views are playing out in the investment space, where investors appear to have differing views on future prospects for Chinese firms.

Benziga reports that China A-shares exchange-traded funds (ETFs) saw an outflow of US$2.37 billion last month—the largest since December—as investors cash in ahead of what looks like more bad news for the Chinese economy. Valuations of A-share listed stocks have become expensive relative to their Hong Kong counterparts. Consider that Shanghai A-shares are trading at 13.3 times forward earnings (versus the MSCI China, which trades at 10 times).

That’s the doom and gloom camp.

But as investors ditch stocks of mainland China’s largest companies, some have set their sights on smaller companies. According to Bloomberg, two ETFs that buy mainland-traded Chinese stocks with assets of less than US$45 million have outperformed 1,500 U.S.-listed funds so far this year.

Says Bloomberg:

The Market Vectors China AMC SME-ChiNext ETF, which focuses on technology and software companies, has surged 49%. The Deutsche X-trackers Harvest CSI 500 China-A Shares Small Cap ETF has gained 37%.

The small cap market is growing rapidly on the back of promises from the government to support developing industries such as technology and healthcare—industries that can help diversify an economy that is still too concentrated in slowing areas such as manufacturing and property development.

So investors are still focused on China. They’re just trying to figure out where its future lies and how to tap into what could be its 1940s moment, with a bright and profitable future ahead.

It’s worth noting, however, that China is apparently experiencing an irrational moment: Bloomberg reports that in the span of just two weeks, China’s stock rally sparked 2.8 million rookie investors to open up new equity accounts (the equivalent of the population of Chicago). More than two-thirds of new investors don’t have a high school degree, and signs of inexperienced investors’ influence on China’s stock market are appearing, particularly in penny stocks, which have outperformed.

Whatever kind of moment China is having, there are a lot of different factors at play—exactly what kind of future they lead to, however, remains open for debate.