Chinese New Year is right on the corner. With iShares FTSE/Xinhua China 25 Index (FXI) down over 65% from its peak set in Oct 2007, many investors think it is the right time to get in. After all, this year is OX year in China. But will it mean bull for FXI? I don’t think so.
Based on the latest statistic released last week (Source), China’s GDP for 4th Qtr of 2008 was up 6.8%. According to Goldman Sachs, it is the slowest Qtr growth since 1998. The 2nd Qtr of 1998 was also 6.8%. For the whole year of 2008, GDP growth was 9%, much lower than 2007’s 13%.
Chinese official aim is for 8% growth for 2009. However, the Wall Street Journal reported that Morgan Stanley’s forecast for China’s 2009 GDP is 5.5%. (Source). Even those growth numbers are what most developed countries such as US/European counties dream for, but for China, it is only half it was 2 years ago. Also, China’s CPI in 2008 was up 5.9%. Therefore, the real GDP growth might be negative for 2009.
As you can see in the chart below from iShares, the financials sector accounts for more than 45% of FXI. As this worldwide crisis began from financial systems, who can guarantee that China’s financial sectors can be immune? Even with a 4 trillion Yuan ($585 billion) stimulus plan announced by the Chinese government last November, the result will be just like US banks: banks’ equity slowly but surely are diluted and wiped out by government’s cash injection. That’s one of the reasons why in recent weeks, foreign banks sold their shares in Chinese banks, though many may argue that those banks such as Bank of America Corp. (BAC) and Royal Bank of Scotland PLC (RBS) did it because they are in need of cash by themselves.
click to enlarge
I bought FXI when it was first launched in last 2004/early 2005; the price was $54 (before spit, or $18 in today’s price). I sold out 1 year after and regretfully missed one of the greatest bull markets in China. However, I believe stock price should reflect its fundamental. Over the last 4 years, China’s GDP growth was at double digits, then FXI’s price (which represents the backbone of its economy) should also increase by that amount, or around 50% after 4 years compounding. So today’s price for FXI should be reasonable at best. It is certainly not cheap, given the uncertainty around the world and for the reasons I pointed out above.
Nobody knows when China will go back to its double-digit growth. That’s why it is paid to wait. However, traditionally Chinese companies (actually, most of Asian companies) don’t pay dividend or pay very little. Currently FXI’s yield is 1.7%, according to MarketWatch.com. (Though many highly respected websites such as Seeking Alpha and Yahoo show higher yield of 2.7% - 4.6%, which is due to an error of 3:1 stock split occurred on 07/24/08).
Nevertheless, many obvious reasons (such as a huge market, higher savings rate, etc.) make lots of investors (including me) believe FXI is a very good long-term investment. Following are four that I think are the most important:
- The Chinese government has enormous resources (including mass foreign reserve) and authority at its disposal to stimulate the economy because the potential for domestic instability in an economic slowdown is very threatening to the government.
- Retails sales was still up by 21.6% in 2008, even higher than 2007’s 16.8%.
- 2008 foreign direct investment (FDI) in China was $92.4 billion, increased by 24% over 2007 (Source). While many emerging markets including other BRIC countries had negative FDI.
- The most important reason is that Chinese Yuan is undervalued. According to the famous Big Mac Theory (or purchasing-power parity, the notion that a dollar should buy the same amount in all countries), Yuan is undervalued around 49%. (Source)
In theory, with all things being equal, FXI should increase by the same amount. You can also use WisdomTree Dreyfus Chinese Yuan (CYB) if you believe Yuan will be up in the long run. However, a foreign currency ETF like CYB is a black box and certainly not good for long term holdings.
To sum up, though FXI is for sure a long-term investment idea, I believe it is reasonably priced now and certainly not cheap. There are lots of other safe places for you to put your cash to work. For now I will keep this in my watch list. I will buy it when it drops below $20. Besides, I already own iShares MSCI Emerging Markets Index (EEM) which includes China.
Disclose: I don’t have a position on FXI at this moment.
