China’s Economy May Be Getting Back on Its Feet. Investors Are Still Cautious.

“It feels like the economy is getting back on its feet,” he said. “The big shift that was a gamechanger is that the private spending that was falling through spring and summer has bottomed out.”

Retail sales have seen a bounce and the firm’s index of Chinese economic activity was picking up. Still, pockets of weakness persist: Manufacturing activity in October dipped back into contraction territory and construction activity slowed because the property sector is still struggling.

However, Sheets, who spent time earlier in his career in the Treasury Department, also noted that while Chinese consumers are cautious, they aren’t as hesitant to spend as feared earlier in the year. A combination of improving private investment and continued government stimulus should continue to steady the economy, he argued. Officials appear to be committed to keeping growth around 4.5% to 5% next year, Sheets said.

That doesn’t mean Sheets is bullish. He says China faces severe risks, both because high levels of debt limit the government’s capacity to offer fiscal stimulus and because it isn’t clear what might replace the still ailing property market as a source of economic growth. Tensions with the U.S. and continued government pressure on China’s technology add to the challenges.

As a result, he said, the medium- to long-term outlook is uncertain even if the odds that the economy can grow at 5% in the near term have improved.

Investors appear to recognize that. The iShares MSCI China exchange-traded fund (ticker: MCHI) is down almost 10% this year, putting it at roughly half of its peak level in 2021. Domestically oriented shares are still struggling too. The iShares MSCI China A-shares ETF (CNYA) is down 13% so far this year.

Even the cheap price tag on Chinese stocks—the CSI 300 is trading at a fifth of the valuation of the Nasdaq—may not entice longer term investors. Indeed, since the beginning of last year, allocations to China have fallen the most among diversified Asia ex-Japan regional equity funds, according to EPFR Global.

For some strategists, including DataTrek Research’s Nicolas Colas, it makes sense to favor U.S. over foreign stocks broadly. He said in a research note that non-U. S. stocks have had a lousy record versus U.S. stocks since 2010.

Looking at trailing 250-day relative returns, the MSCI All Country World ex-U. S. beat the S&P 500 as markets worldwide rebounded from their March 2009 financial crisis lows. But since then, there have been only five periods where non-US stocks have beaten the S&P 500 over a calendar year.

That makes it more likely that this year’s outperformance by international stocks in the MSCI All-Country World index may be coming to an end, he said.  

While Chinese stocks have also outperformed the S&P 500 over the past year, Colas told Barron’s, it may be worth waiting a month or two before selling them, given that growth in the Chinese economy is more likely to accelerate than in Europe or Japan.

But Chinese stocks’ long-term returns are exceptionally poor, so it makes sense to lighten up on them over time, he said.

Write to Reshma Kapadia at [email protected]