Despite widespread sentiment that China was uninvestable, the country became one of the world's best-performing markets. This demonstrates how a powerful negative narrative can create significant opportunity for contrarian investors who focus on fundamentals, as the cheapest quintile of Chinese stocks remains attractive.
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For D1 Capital, the primary risk in China isn't economic but political. The government's ability to arbitrarily influence resource allocation, punish successful companies, and eliminate entire sectors without due process creates an unacceptable level of uncertainty for capital allocators, regardless of how cheap valuations become.
China's harsh, deflationary economic environment and intense domestic competition, while causing many companies to fail, effectively hones a select few into highly resilient and efficient champions. These survivors are now prepared for successful global expansion.
After being 'shunned by the world for 10 to 15 years,' emerging market assets are benefiting from a slow-moving, structural diversification away from heavily-owned U.S. assets. This long-term trend provides a background source of demand and support, contributing to the asset class's current resilience against short-term volatility.
For years, China acted as a primary capital magnet within emerging markets. However, recent policy shifts have increased unpredictability, changing its role in global portfolios from a long-term, strategic investment to a short-term, tactical trade.
Following a 30-40% valuation surge in 2025, China's market is expected to stabilize. Further upside in 2026 will depend on corporate earnings, projected at a modest 6%, signaling a shift from a valuation-driven to an earnings-driven market that requires a different investment approach.
Citing research from Verdad's Dan Rasmussen, the speaker notes that EM assets perform best when purchased during a crisis that originates in developed markets (e.g., the GFC or COVID). Panicked selling creates widespread mispricing in EM, even though the region is not the source of the crisis, offering a prime buying opportunity.
Investors often mistakenly equate strong economic growth with strong stock market performance. Historical data, particularly China's market performance versus its GDP since 1992, shows no reliable correlation. Starting valuation is a far better predictor of long-term returns.
Profitable Chinese giants like ByteDance trade at a fraction of their Western counterparts' multiples. This "China discount" stems not from business fundamentals but from the unpredictable risk of the Communist Party "smiting" successful companies and overarching geopolitical tensions, making them un-investable for many.
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Contrary to the view of a monolithic state, China's economic strength comes from intense competition between its provinces. This hyper-local market forces companies to become incredibly resilient, and only the strongest, like BYD, survive to dominate globally.
Despite geopolitical tensions, Hong Kong is re-emerging as the top destination for IPOs and the primary conduit for Western capital seeking exposure to China. As major asset managers look to diversify away from overweight U.S. portfolios, Hong Kong's financial markets are poised for a record year, providing a crucial and accessible entry point to the Chinese economy.
