China: When Good News Is Not Good

Includes: BIDU, CHIQ, FXI
by: Emerging Money

By Joseph Hogue, CFA

It’s been perverse dynamic in the equity market for Chinese shares. Investors have been torn between the hard- vs. soft-landing debate for the last year as economic data continues to weaken. The weakness in data has led to a manic-depressive environment of sell-offs on the headline, followed by a rebound on hopes of government stimulus.

The sell-the-news, buy-the-rumor environment has kept many issues rangebound, with the iShares FTSE China 25 (NYSEARCA:FXI) basically flat over the last 12 months through October. Since the beginning of November it seems as if there has been a noticeable change in market sentiment. The Shanghai Composite index saw one of its longest losing streaks of the year, falling five days before a marginal rebound on Monday, and the FTSE 25 index has lost almost 6% since the beginning of the month.

What has turned the market sour? Good news. Industrial production increased by 9.6% over the year to October and retail sales rose by 14.5%, both reports beating expectations. Fixed-asset investment was also reported above analyst estimates for a gain of 20.7% year to date, while consumer and producer prices continued to show benign inflationary pressures.

The People’s Bank of China cut interest rates twice earlier in the year and reduced banks' required reserve ratio three times since last November. Many analysts, myself included, were hoping that the new administration would put its own stamp on the economy with new measures after the party congress this month.

Better economic data now has the market second-guessing its hope for further monetary and fiscal stimulus from the new government, and this is acting to depress sentiment. While economic data has improved, it is not at the point which the government can sit back and wait. GDP growth in the third quarter came in at its weakest in years and under the government’s official target.

Even without significant government stimulus and single-digit growth, there are still several sectors that trade at extremely attractive multiples. The government has targeted the consumer space for growth as it transitions from an export-led economy.

The Global X China Consumer fund (NYSEARCA:CHIQ) trades for a higher multiple than the general market, but gives investors exposure to one of the most attractive sectors. The iShares China fund trades for just eight times trailing earnings and makes a good, diversified bet on the larger market.

I am long Baidu (NASDAQ:BIDU) at a multiple of 22.3 times trailing earnings, its cheapest in a decade. The company is the undisputed leader in China search, and Google's (NASDAQ:GOOG) recent blackout around the party congress leads me to believe the U.S. behemoth will not pose too much of a competitive risk in the near future. Internet usage in the country continues to grow at double-digit rates, with penetration still under 35%.

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Tagged: China
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