Chinese equities and currency have been sold down due to the trade war and China slowdown fears, but are now very cheap compared to US equities.
Some reasons to consider investing in China at this time.
Some reasons for not investing in China at this time.
China investment options.
This article first appeared in Trend Investing on September 16, 2019; therefore all data is as of this date.
The US-China trade war has taken a heavy toll on most Chinese equity funds, especially when compared in USD terms (as the Chinese yuan has weakened). The growth rate is higher in China (GDP is 6.2% pa) than in the US (GDP is 2.3% pa) and the Chinese equity market is at a much lower valuation (China P/E 12.3, USA P/E 21.0). Just looking at the figures quoted above indicates that China is growing 2.7x faster than the US, and China's equity market is 41% cheaper, or almost trading at half the US valuation.
US versus China (& Hong Kong) equity markets since the trade war began in March 2018 to May 2019
China is growing much faster than the US
Some reasons to consider investing in China at this time
- China's growth is 2.7x higher than the USA. (6.2% pa versus 2.3% pa)
- China's equity markets are valued 41% cheaper than the USA. (P/E of 12.3 compared to 21.0)
- The rising China middle class (400 m and growing fast), and urbanization. China is building megacities at a rapid pace. For example, the city of Shenzhen has grown from a small town of 300,000 in 1980, to a high tech city of over 11 million today. China has over 160 cities that have a population of over 1 million people. Urbanization is currently at ~59% and forecast to reach 70% by 2035. This means there is still about 2 decades ahead of rapid construction-led growth as China continues to urbanize.
- China is creating more millionaires than any other country on the planet.
- China's transportation and tech sectors are now innovating and becoming leaders. China has world-class transport systems (including high-speed rail, and a leader in electrification of the transport sector). Chinese tech companies are now very innovative. China has the world's leading drone company. China is leading with on-the-ground tech adoption - Fintech (E.g: smartphone payments and cashless society), automation (stores & restaurants run by robots, driverless vehicles), and artificial intelligence (facial recognition, etc).
- Large money flows are heading into Chinese stocks. The MSCI Emerging Markets Index change will include a final 5% of China large caps in November 2019, as well as large flows into Chinese mid caps. As stated by CNBC: "MSCI said it will increase the inclusion factor of Chinese large-cap stocks to 20 percent from the current 5 percent in three steps, in May, August and November this year..... MSCI also announced that it will add Chinese mid-cap stocks to its emerging market benchmark in November, boosting the number of Chinese constituents." Chinese pension funds will also be investing trillions into Chinese stocks over the next decade, to help fund Chinese retirees. Note the additions will be from China A (mainland) shares. You can read more here.
Note: Even after China's 2019 increased weighting in the MSCI Emerging Markets Index, China will still be only 3.3% of the index, yet China's GDP is ~19% of world GDP (adjusted for purchasing-power-parity in 2019). Even worse when we look at the iShares Global 100 ETF (IOO), China gets zero allocation. Clearly, there is room for further future increases.
The global economy - GDP per country in 2017
Source: Visual Capitalist
Shenzhen - From 300,000 in 1980 to 11 million in 2019 - it is now the global epicentre of high tech manufacturing
Shanghai is now a sophisticated metropolis
Some reasons for not investing in China at this time
- The US-China trade war. Many companies are considering moving their manufacturing out of China. China's exports to the US are declining. On October 15, 2019, the US intends to raise the existing tariff rate on Chinese products to 30% from 25% on USD 250b of Chinese goods. Then on December 15 the US intends to add new tariffs of 15% on US$160b of Chinese goods.
- Demographics have turned - ageing population.
- China debts are large. Total debt to GDP is ~249%; however, they are less than other major economies (Japan - ~650%, UK - 550%, US - 350%). See chart below.
- China has 50-65 million empty apartments (~20% of city stock). To offset this is the urbanization rate of around 20m moving to the city each year.
China's debt is quite high (mostly due to corporate debt)
China urbanization - About 21m Chinese moved to the city in 2017
China investment options
- Direct Chinese shares - The BAT shares are similar to the US FANG stocks. BAT stands for Baidu (BIDU), Alibaba (BABA), and Tencent (OTCPK:TCEHY). Smaller tech names with potential include Momo (MOMO), CTrip (CTRP), and iQiyi (IQ).
- China ETFs
- iShares China Large-Cap ETF (FXI) (P/E is 10.36). The top ten holdings are shown below.
- iShares MSCI China Small-Cap ETF (NYSEARCA:ECNS) (P/E is 8.82) Top ten holdings are shown below.
- Global X MSCI China Information Technology ETF (CHIK) (P/E is 23.53) Top ten holdings are shown below. Valuation looks a bit high right now.
- Direxion Daily China 3x Bull Shares (YINN) - This is for very aggressive investors as it is leveraged to achieve 3x return on an index of the 50 top stocks in the region. The bear 3x version is YANG. Sadly both funds have had negative 5-year returns, suggesting the cost of leverage is not working over the long term. I would skip this one unless you are a short-term trader.
Of the above, I would choose one of the MSCI funds given the MSCI index change. Arguably, the iShares MSCI China A ETF should benefit most due to its A share focus.
My longer term pick would be the iShares MSCI China ETF as it has good exposure across several key sectors (tech, financials, communications) and a low P/E of 12.26. It also holds China's top two tech stocks in Tencent and Alibaba in large weightings. Each of these companies has a dominant market share, plenty of free cash flow, and investments into hundreds of other related companies.
- The Chinese Government controls China and their state-owned institutions. This means the PRC Government can impact certain businesses negatively if they so choose. We saw this last year with a cut-back in the gaming industry that impacted Tencent negatively.
- The Hong Kong protests have reduced sentiment, especially in Hong Kong-listed Chinese stocks.
- Many US investors are wary of Chinese equities.
- The US-China trade war outcome. On October 15 the US plans to increase the tariffs on Chinese goods and add new tariffs on December 15.
- Currency risks.
Investors should definitely spend an hour and watch the video link below, to get a very good feel on what's happening in China.
- New Money: The Greatest Wealth Creation Event in History (2019) - Full Documentary (video)
- Trade war: US-China trade battle in charts
- Why China Is Emerging as a Tech Superpower to Rival the U.S.
- 400 million strong and growing: China’s massive middle class is its secret weapon
- 7 Great ETFs to Buy to Invest in China
China is forging ahead in technology - A global leader in drones is just one example
China is definitely under pressure due to the trade war and some excess debt; however, this is why most Chinese equities are trading so cheap. My view is that the negatives are priced in at this time. Sure, Chinese equities may fall further if the trade war worsens further, or they may recover sharply if we get a swift trade war conclusion. In any event, current cheap Chinese equity valuations now warrant some consideration.
Risks remain if the trade war worsens, and risk due to increased and new tariffs due to hit China on October 15 and December 15, 2019.
The old adage goes "buy low and sell high." The hard part is buying low always means sentiment is usually poor and uncertainty high - After all this is why fast-growing China is currently valued so cheaply.
Given the already weakened Chinese currency, low equity valuations, strong GDP, rising middle class, rising tech cities, and two decades ahead of urbanization and greater internet penetration, I think it is a good time to start an initial position in China. Raised and increased tariffs on China in the months ahead mean investors should not yet get carried away on China as more short-term pain could be ahead; however, a trade war solution would cause a sharp recovery in Chinese equities.
As usual all comments are welcome.
Thanks for reading the article. Sign up for Trend Investing for my best investing ideas, latest trends, exclusive CEO interviews, chat room access to me, and to other sophisticated investors. You can benefit from the work I've done, especially in the electric vehicle and EV metals sector. You can learn more by reading "The Trend Investing Difference", "Subscriber Feedback On Trend Investing", or sign up here.
Latest Trend Investing articles:
Disclosure: I am/we are long MCHI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information in this article is general in nature and should not be relied upon as personal financial advice.