China is reinventing the equity markets – and Britain’s aspirations are shrinking

First, the exposition:

  1. Exuberance for equity as a class of investment reflects how confident a given society is in their future; preference for fixed income indicates the opposite
  2. China has been reinventing the equity markets for some time now, becoming the first country since the rise of the US to really have the risk appetite for it
  3. In doing so it is breaking the convention of maturing countries in the region (Japan, Korea, Taiwan) as well as ageing civilisations such as Europe
  4. As with so much else, China is the new America

The above can be seen in a number of ways. Consider this: despite the scare stories about rising Chinese debt, it is in fact equity (both institutional and private capital) which has mostly funded fixed asset investment in recent years – averaging 66% over the last decade versus just 52% over the decade before. Anecdotally too, we know that all around us in China new startups have no problems accessing micro-equity from friends and family for the most spurious of businesses.

Self-raised funding as a % of fixed asset investment in China, 1995 – 2016

Self-raised funds.png

Source: National Bureau of Statistics

Note: the NBS splits out five categories of funding for FAI, namely Government Budgetary Funds, Domestic Loans, Foreign Investment, Self-Raising Funds and Other Funds. It is reasonable to assume that Self-Raising Funds constitutes equity investment, and that a portion of Foreign Investment may also do.

Likewise, institutional equity and equity linked investments account for a higher proportion of Chinese asset allocation than their East Asian peers – and are more reminiscent of the US in approaching 60% of allocations. Conservative Japan and Korea are the reverse. Small wonder then, that annual stock turnover in China is far higher than other markets (around 5.0x compared to c. 1.5x in the US, Korea and Japan) given the limited supply of listed equity.

Equity proportion of total non-cash household financial assets, 2016

China vs peers portfolio allocation.png

Source: Goldman Sachs Investment Research, 2016

Again, this reflects the fundamentals of not only an economy, but the society on which it sits. Buoyant equity markets reflect confidence not just in business, but in the system and the role of a country in the world. This is especially true when we think about equity provided by the retail markets, either through stock markets, or its proxies, or through earlier stage funding such as seed and venture funding where China is now the world’s second largest market. The basic principle is that when tomorrow seems like it will be better than today, people will gamble.

China still has a long way to go, of course. Its stock market capitalization per capita at c. US$6,000, still lags its peers and is just one thirteenth that of the US (and no, PPP is not appropriate here). Its private equity market, though already Asia’s largest, still has some way to catch up also at only one-third of North America. Nonetheless, China seems to be well placed to pick up the baton from the US of driving the whole culture of equity and all its attendant benefits.

And it matters. The point about equity is not just that it is one source of funding, but rather that it is a source of long-term funding and seeding for growth. A country that begins preferring fixed income to equity is giving up on its future, but also giving up on the idea of being a leader in innovation and technology. It is no coincidence that America has been the world’s great equity proponent for the last century and the cradle of  most technology; or that China is following in its footsteps. These are the hallmarks of “big countries” that make their own rules and are a force in the world.

On the other hand, a country like the UK should be very worried indeed: equity in portfolio allocations has declined alarmingly from well before the 2008 crisis. This reflects some ageing – but the ageing profile is less severe than many of its neighbours. Rather, I believe it reflects a psychological retreat from aspiration.

Changes in broad strategic asset allocation for UK plans, 2003 – 2017

UK asset allocations

Source: Mercer European Asset Allocation Survey 2017

This, much more than Brexit or the reduction of blue water navy capacity, indicates the decline of British aspirations. On a recent podcast, someone asked “but how close is China to really producing an Apple?”; the curt reply came, “how close is Britain?”, alluding to the even greater absurdity of such a prospect. If this continues, Britain will certainly no longer be a “big country”.

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