Why You Lost So Much Money Investing in China

Last week’s news that China’s economy is set to overtake the U.S. economy in size by the end of this year was greeted with a collective yawn by the U.S. financial press.

It’s easy to see why. China bulls have had a rough five years.

The Shanghai Composite Index closed yesterday at 2028. That’s almost a 67% drop from its Oct. 16 peak of 6,124 in 2007. It’s also 21.7% below the 2592 level it closed at exactly five years ago.

U.S. investors don’t care about the size of China’s economy because, well… it hasn’t made them any money.

“The China Miracle” now has underperformed the U.S. S&P 500 by more than 120% over the course of the past five years.

I hate to say I told you so… but “I told you so” both in writing and in video.

The China Obsession Recalled

Exactly six years ago this week, I sat on a panel on “global investments” at the Las Vegas Money Show.

The panel consisted of four members. Three of them were either China newsletter writers or Chinese fund managers. As a “non-China” specialist, I was a politically correct afterthought.

When I pointed out that there were other investment opportunities out there — I mentioned Brazil — one (now bankrupt) China guru shook his head knowingly. With no hint of irony, the guru said that Brazil was actually a “China story,” as were Apple, Pizza Hut and Starbucks.

To a man with a China hammer, everything was a nail.

The reality is that the future is never as certain as we think it is.

I pointed out that had our panel convened in 1908, we’d have been telling investors about the remarkable opportunities in Russian railroad bonds; the fast-growth economies of Austria-Hungary; the dynamism of Argentina; and the new behemoth of the global economy, the United States.

And we’d all have been wrong.

Twenty years later, in 1928, both Russia and Austria-Hungary had been wiped off of the map; Argentina was an economic basket case; and even the United States — the only long-term winner among the group — was about to enter the Great Depression.

Nor do you have to go back 100 years. In a book published in 1989 on the United States in the first decade of the 21st century, the words “China” and the “Internet” aren’t even in the index. The World Bank’s book on “The Asian Miracle,” published in 1993, fails to highlight China, focusing on Japan and the “Asian Tigers” instead.

Back in 2008, not one of us on that panel knew what “fracking” was. Yet by 2020, fracking will turn the United States into a bigger oil producer than Saudi Arabia.

The world changes in ways we cannot even begin to imagine.

The Chinese Stock Bubble: A Textbook Case

The “boom and bust” in the Chinese stock market was similar to the Internet boom in the 1990s. Like the Internet, China changed the way much of the world did business. As with Internet stocks, for a while it seemed like any stock from China was a no-lose investment.

But as with all financial manias, the collapse of the Chinese stock market was not a question of “if” but of “when.” The Chinese index had been up sevenfold during the five years prior to its peak in 2007. Valuations of major companies hit price-earnings (P/E) ratios of 60. When I placed the chart of NASDAQ during the tech boom over the chart of the Shanghai index, I could barely tell the two markets apart.

I had seen this story before. At the end of the 1980s, Japanese banks and telecommunications companies headed the list of the world’s most valuable companies. In October 2007, the same list was led by Chinese banking, insurance, telecoms and airlines. China accounted for four of the world’s top 10 companies — China Life, China Mobile, China Petroleum and Industrial and Commercial Bank of China (ICBC).

Fast-forward six years to 2014 — and there isn’t a single Chinese company in the global top 10.

The China Obsession: The Future is Not What It Used to Be

I don’t know how the Chinese economic story will unfold. But neither did any of China’s new-fangled experts on that panel in 2008.

I do believe that China’s economic fate will develop in ways completely different from what today’s China experts believe.

But if you ever want to get a glimpse of the future of your investments in the “next big thing,” read a good financial history like Edward Chancellor’s “Devil Take Hindmost: A History of Financial Speculation.”

As amazing as the money-making opportunities in the “China Miracle” appeared in 2008, it will be even more amazing how off the mark it will seem in 20 years.

In case you missed it, I encourage you to read my Global Guru article from last week about a shockingly simple way to improve your investment returns. I also invite you to comment in the space provided below.