China is likely to avoid the middle-income trap. But investors should beware the pitfalls of focusing only on headline growth
- Economic growth is important, but investor returns depend on more than that. In China’s case, the deepening and opening up of its financial markets are factors that will boost returns – and help it escape the middle-income trap
China’s economy stands at a key juncture. The route it takes will have a complex impact on the world’s financial markets. Reviewing the historically nuanced relationship between economies and markets helps to put this in context.
Emerging markets’ high rates of growth are often pointed to as a key reason to buy into their stock markets, but economic growth is not the sole determinant of returns. High growth does translate into higher revenues – an important component of total returns – but fast-growing emerging markets can also see dilution.
Dilution happens when a company issues additional shares of stock, often because they need more capital to invest, zapping the value of existing investors' shares by reducing their proportional ownership. Dilution lowers returns to investors, below what revenue growth would have suggested these stocks are worth.
The fact that growth doesn’t necessarily dictate investor returns is an interesting paradigm for Beijing, if we broadly consider the effect of China’s slowing future growth on its markets.
During 2019, China will pass a milestone in its development: its per capita gross domestic product, measured using market exchange rates, will reach US$10,000. At that mark, China will be considered a “middle-income country”.
China’s per capita GDP has doubled since 2011 and increased 10-fold since 2000. This massive improvement in the living standards of a population that exceeds 1 billion has been one of the quickest and biggest economic success stories in history.
