Last month, I wrote that investors shouldn’t dismiss China just yet, since indicators were signaling a softer landing than some have feared. Now, new economic data supports our view that investors should consider an overweight to Chinese stocks.
Last week, China reported third quarter gross domestic product (GDP) growth in line with economists’ expectations of 7.4%, but other measures suggest that the economy may soon accelerate, including the following:
- Exports rebounded strongly in September, up 9.9% compared to the previous year.
- China’s broad measure of monetary supply (M2) is now expanding at nearly 20% a year, the fastest pace since the spring of 2010.
- Retail sales are also starting to accelerate, after steadily declining during the first half of the year.
Our expectation is that Chinese growth has probably slowed to around 7.5%-8%. We believe that the more dire predictions of a Chinese hard landing appear less likely, and recent market selling is overdone.
Relentless selling has pushed valuations down close to historic lows. Chinese stocks are down a stunning 66% from their 2007 top, based on the Shanghai Composite Index. Chinese equities are now trading at approximately 1.3 times book value and less than nine times next year’s earnings. On a relative basis, the Chinese stock market has never looked cheaper. Historically, Chinese stocks traded at a 56% premium to other emerging market (EM) countries, but today, they are trading at a 10% discount. This looks especially cheap when you consider that most other EM countries have also been slowing, yet China still boasts some of the fastest growth in the world.
China is also inexpensive compared to developed markets. In the United States, large cap stocks are up 120% from their 2009 lows, rebounding to within striking distance of their 2007 highs, even though the country’s recovery has been a disappointment by any measure. So far in 2012, Chinese equities are down no more than 2%, but they are still 42% below their 2009 peak. While Chinese growth is unlikely to revert back to the glory days of 2010, when the economy expanded by over 10%, it looks like current valuations now more than reflect the slowdown in growth.
With valuations now inexpensive by any standard and growth stabilizing, China may finally be carving out its own bottom. As such, we would continue to advocate an overweight to Chinese equities through funds like the iShares FTSE/Xinhua China 25 Index (NYSEARCA:FXI), iShares MSCI China Index Fund (NYSEARCA:MCHI) and iShares MSCI China Small Cap Index Fund (NYSEARCA:ECNS).
Disclaimer: In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country and investments in smaller companies may be subject to higher volatility.