Subsidizing China's Superpower Aspirations

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Includes: ACWI, CHN, CN, CXSE, FCA, FLCH, FXI, FXP, GCH, GXC, JFC, KGRN, MCHI, PGJ, TDF, WCHN, XPP, YANG, YAO, YINN, YXI
by: WisdomTree

By Jeff Weniger, CFA, Asset Allocation Strategist

Christine Lagarde, head of the International Monetary Fund (IMF), is warning that China's Belt and Road Initiative - the potentially multitrillion-dollar network of roads, rails, pipelines and other infrastructure across Eurasia - risks saddling unstable governments with unpayable debt. Because of the IMF's concerns, it plans to fund the China-IMF Capacity Development Center (CICDC) to train the Chinese to minimize the headaches caused by this century's Marshall Plan. If all goes according to plan, the Belt and Road project will connect land- and sea-based trading routes to cement China as the center of global commerce in a decade or two.

While China appears to be ascending into world superpower status in the coming decades, a $100 investment in "global" equities allocates just $3.51 to the country, if we track an index like the MSCI All Country World (NASDAQ:ACWI).1 That seems remarkably low for a country that is going head-to-head with the U.S. on the global stage.

It was only last year that MSCI announced it would be adding Chinese A-shares, companies listed in Shanghai and Shenzhen, to its MSCI Emerging Markets Index. That is late for an economy whose size surpassed the U.S. in 2014, at least on a purchasing power parity basis (see chart below).

China & U.S. Shares of Global Gross Domestic Product

Covering China, Wherever the Listing

While some Chinese companies are only available in Shanghai or Shenzhen, others are listed solely in Hong Kong. Still others have American Depository Receipts (ADRs) or are traded in Singapore.

The WisdomTree ICBCCS S&P China 500 Fund (NYSEARCA:WCHN) ETF tracks the S&P China 500 Index, before fees and expenses, covering stocks in all those bourses. This index currently holds over 50% in local A-shares. MSCI, by contrast, is only starting to add A-shares securities up to a 5% inclusion factor in 2018, a small starting point. It's high time China has its own S&P 500, especially if President Xi Jinping has anything to say about it.

Going Out

Deng Xiaoping, ruler of China from 1978 to 1989, famously advised his country to "hide your strength, bide your time." China's great goal of the last four decades - development, development, development - was to happen quietly, with fingers crossed that the U.S., Japan and Western Europe wouldn't get too frightened.

The hiding and biding is over. Xi's 2017 Davos speech, replete with all the platitudes about smiling outreach, set the template for an acceleration of "Going Out," Beijing's euphemistically named colonialism in central Asia, Africa and client states as far as Latin America.

Recall that the big issue for about two minutes in 2015 was Britain's fence-sitting on joining the Asian Infrastructure Investment Bank (AIIB), China's answer to the IMF, World Bank and other such supranational bodies. The U.K. held strong for a bit, until fear of missing out caused it to relent and join the infrastructure bank. Development banks have metastasized through the years, and the AIIB is the new kid on the block, so the IMF will try to keep up.

And while U.S. politics splinters into ever-more-hostile factions, Europe is distracted by its own fragile fabric. Britain? Tied up with Brexit. Meanwhile, the Asian hegemon flexes muscle. Look at the three votes against Syrian air strikes: China, Russia and Bolivia, the latter being one of several South American puppet governments. China is going to do what China wants to do.

Spreading its influence across the world's largest land mass - and beyond - is the new goal for China, and the IMF is going to help the cause, adding resources for the Belt and Road, as if China needs money. This is the new Marshall Plan, and with the U.S. "donation" to the IMF three times larger than China's,2 the West is paying for its own relative decline.

Beijing is sitting on a $3.1 trillion foreign exchange reserve fortress, is the global leader in mobile payments, is home of Amazon (NASDAQ:AMZN)-esque Alibaba (NYSE:BABA) and Tencent (OTCPK:TCEHY), is number two in international patent applications, and on and on.3 And the U.S., Japan, France - all of the usual suspects - are funding the IMF, thus training the Chinese in their industrialization efforts.

Allocate accordingly.

Xi, ruler for life, intends to plant a figurative flag as the global leader of the 21st century. Again, China's current weight in MSCI ACWI is 3.5%, the same amount as France.4 If the future China looks anything like the U.S. in the 20th century or Britain in the 19th, 3.5% of the pie is off the mark.

1 Source: MSCI ACWI, as of 12/31/17.

2 Source: IMF Members' Quotas and Voting Power, and IMF Board of Governors, 4/15/18. China's quota is 6.4% of the total, while the U.S. has the largest quota, at 17.5% of the total.

3 Source: Statista, for 2017. Click here for current holdings of WCHN. [links to fund page]

4 Source: MSCI, as of 12/31/17.

Jeff Weniger, CFA

Asset Allocation Strategist

Jeff Weniger, CFA serves as Asset Allocation Strategist at WisdomTree. Jeff has a background in fundamental, economic and behavioral analysis for strategic and tactical asset allocation. Prior to joining WisdomTree, he was Director, Senior Strategist with BMO from 2006 to 2017, serving on the Asset Allocation Committee and co-managing the firm's ETF model portfolios. Jeff has a B.S. in Finance from the University of Florida and an MBA from Notre Dame. He is a CFA charter holder and an active member of the CFA Society of Chicago and the CFA Institute since 2006. He has appeared in various financial publications such as Barron's and the Wall Street Journal and makes regular appearances on Canada's Business News Network (BNN) and Wharton Business Radio.