Time To Buy China ETFs?

Includes: FXI, HAO
by: Emerging Money

By Steven Orlowski

Billions of investment dollars have started flowing back into China recently. Indications are that the Chinese economy is stabilizing and that investors are becoming concerned they might miss the recovery. Challenges persist, however, and the short-term future is uncertain.

As reported by Reuters, nearly $4 billion as gone into Chinese equity funds in the past two months. Also according to Reuters, sentiment seems "to be running ahead of fundamentals. There are clear risk signals for the Chinese market -- including sluggish earnings, rising corporate debt and retail investors looking for other opportunities -- even if the broader economy gathers strength."

Low valuations are attracting these investment dollars as well as the perception that China's slowdown seems to be stabilizing. China still offers an attractive long-term investment opportunity even if problems persist. Reuters also noted that a recent Bank of America Merrill Lynch "global survey of fund managers, covering 248 managers with $695 billion of assets under management, found confidence in China’s economy was at a three-year high."

The MSCI China index trades at a forward price-to-earnings multiple of 9.2, less than Brazil at 9.9 and India at 13.2. Last week's PMI reading delivered the first expansion in manufacturing in more than a year. The Reuters article cited other data, including inflows into China equity funds of nearly $4 billion over the 10 weeks to mid-November, that two-thirds of Chinese companies have missed expectations for third- quarter earnings, that profits have fallen at an annualized 5.8% and consensus for next year is being lowered, and that some expectations are for corporate debt to rise to 122% of GDP.

There are mixed messages in the data for sure. However, the iShares FTSE China 25 Index Fund ETF (NYSEARCA:FXI) has had a nice run over the past six months, having moved from about $32.00 per share to around $37.00 per share today. That’s a return of 16%.

Long term, the ETF has more to go before regaining its pre-global crisis highs.

The ETF is up about 100% since its late 2008 lows and has been consolidating nicely since 2011. This sets it up for a breakout, one way or the other. If the inflows to China represent the "smart" money then a greater opportunity may exist with the Claymore/AlphaShares China Small Cap ETF (NYSEARCA:HAO).

Historically small-caps tend to outperform bigger stocks during recoveries and conversely underperform in contractions. HAO has a shorter history than FXI, but it is compelling long term.

The consensus remains that China is a long-term growth prospect. Will it ever grow at the same pace as it was growing just a few years ago? It may, it may not. But it will grow. The short run will certainly present challenging trading environs. The long run should be profitable.