Given the recent recommendations to re-enter the Chinese equity market, I thought it worth comparing the performance and risk of comparable US stocks.
On November 20, Bloomberg reported that “China will reopen According to Hao Hong, chief economist at GROW Investment Group, the Covid-zero lockdown will be gradually lifted and the real estate sector will slowly recover with political support, which will help the country’s benchmark stock index rise by 13% over the next 12 months increase.”
There are three areas of interest: E-Commerce, Internet and Search, and Cryptocurrencies. Let’s take a quick look at each one. (Please note that Chinese stocks listed on US exchanges are ADRs and therefore carry higher risk and do not confer voting rights on shareholders.)
In the US we have Amazon (AMZN). In China, they have Baidu (BIDU), JD.com (JD), and Alibaba (BABA) (OTCPK:BABAF), all large, viable companies. Even conservative traders and bond funds are likely to hold these stocks.
In terms of performance over the past 5 years, all have suffered a global economic downturn. Figure 1 shows the price history adjusted to 100 on January 1, 2017. JD is the closest to AMZN while BIDU and BABA have declined the most. Only AMZN appears to have outperformed S&P over the 5-year period.
Figure 1. Ecommerce stock price history.
In terms of volatility, Chinese equities are two to three times more volatile than AMZN (Figure 2). It is important to size Chinese stock positions much smaller (1/2 to 1/3) than US stocks to achieve the best diversification.
Figure 2. Ecommerce Stock Volatility.
The two most actively traded Internet stocks are Google (GOOG) (GOOGL) and Tencent (OTCPK:TCEHY). As you can see in Figure 3, Google had a smoother path and better ROI than Tencent. If we compare volatility (Figure 4), Google shows 24% and Tencent shows 37%. Overall, Chinese stocks are more volatile than their US counterparts.
Figure 3. Internet stock price history.
Figure 4. Internet stock volatility.
When it comes to cryptocurrencies, Bitcoin (BTC-USD) is the biggest player in the world. Ethereum (ETH-USD) is said to have more commercial applications but is trending similarly to Bitcoin as seen in Figure 5. Prices were set at 100 as of January 1, 2018.
Figure 5. Crypto price history.
The main Asian crypto markets are Tamadoge (Japan) and Tether (USDT-USD) (the largest in Asia after Bitcoin), but they have remarkably short price histories, which is why they have been omitted. We can compare Binance (BNB-USD) with Coinbase (COIN), two popular crypto “exchanges”. In Figure 6, we can see that BNB has held up better than COIN, but is showing significant volatility.
Figure 6. Binance and Coin crypto exchanges.
One of the biggest problems with crypto is its volatility. In Figure 7, we compare the volatility of BTC and ETH to the S&P ETF (SPY). Over the past 5 years, SPY has had an average 20-day volatility of 14.6%, while BTC and ETH have been 55% and 74%, respectively. Exchange volatility (Figure 8) shows that Binance was at 77% versus COIN at 22%. Even if COIN is heading towards zero, its volatility is very low.
Figure 7. Crypto volatility.
Figure 8. Crypto exchange volatility.
Volatility tells us to trade 1/5th of our normal size in BTC or ETH and even less in BNB. It is important that all positions have the same volatility. But the frequent, large spikes present another problem, which we’ll discuss next.
That was the good news
US stocks outperformed Chinese stocks in most comparisons, with less volatility. Often needs to be lowered. We can also see that Chinese stocks experience more volatility spikes than US stocks. Which brings us to the underlying issues when trading Chinese stocks:
- Much like OPEC, the Chinese government is making surprise announcements about its economy and policy changes. We have no advance notice.
- China’s policy on COVID-19 has been strict and full of surprises. They will lock down a city of 1 million people if one person tests positive. On November 3, 2022, they locked down Zhengshou, home of the largest iPhone factory.
- The US has restricted imports of Chinese semiconductors. It has restricted the export of some technologies. This has had a negative impact on Chinese equities.
- Half of Hong Kong’s foreign companies plan to relocate due to government policy.
More importantly, the Chinese have never agreed to allow the New York Stock Exchange to audit their company’s books. We have no idea if the dates are correct. Combined with unexpected policy announcements that increase volatility, a lack of confidence in earnings or capitalization appears to be an even bigger problem. We can measure volatility but have no idea if any of the other numbers are true.
Dealing with broker recommendations
Some brokers recommend buying Chinese stocks after the government changes housing regulations and China eases COVID-19 restrictions. That might turn out to be a good recommendation, but the risks are high. If you participate, it should be from a very small position and in anticipation of another change in Chinese policy. You never know.