Over the past several months, the world has been thrown into a chaotic swirl, and global stock markets have suffered major blows as the Fed is tightening for the first time in years amid skyrocketing inflation in the U.S. and a war between Russia and Ukraine shocked and rattled the world. At such times of high uncertainty, investors all over the world seek the safest harbor to park their investment capital. Believe it or not, this time the safest harbor likely is China, not U.S., and the easiest and arguably the best way for most American investors to invest in China now is buying ETF shares of The China Fund (NYSE: CHN). In this article, we’ll review the background information step by step and share our thought process in detail with our readers.
As the norm set in the world for over the last 100 years goes, U.S. is the global de-facto safe harbor. Thus, when uncertainty mounted and investors sought to avoid risk, most of them parked their money in the U.S. and sold assets in other countries to buy American assets (stocks, real estate, bonds, etc.). As a result, during times of high risk and uncertainty, U.S. dollar always appreciated against other currencies especially those of emerging markets, and U.S. equity market always held better than other equity markets. However, unlike almost all such occasions in the past, a never-seen-before phenomenon has emerged this time around that most American investors, especially retail investors, probably are not aware of. This time, China’s currency Yuan (also called “RMB”) not only has not “surrendered” to U.S. dollar but actually has gained significant ground against the dollar over the last 1 month, 6 months, and 2 years (i.e. over both short, mid, and long term). The following three charts from Yahoo Finance show the vivid trends.
Chart 1: U.S. Dollar To Chinese Yuan Exchange Rate Trend Over Last 1 Month
Chart 2: U.S. Dollar to Chinese Yuan Exchange Rate Trend Over Last 3 Months
Chart 3: U.S. Dollar To Chinese Yuan Exchange Rate Trend Over Last 2 Years
So, why has Yuan appreciated against the dollar? The reason: a significant amount of capital has flowed into China from foreign countries (you bet a pretty large amount is from the U.S.) to invest in Chinese stocks. As shown in the following two charts, over the past 6 months, foreigners’ bank and brokerage accounts in Hong Kong have spent 174 billion RMB ($27.5 billion) to buy stocks listed in mainland China through Hong Kong-Shanghai and Hong Kong-Shenzhen Stock Connects. Unfortunately, this capital inflow data is available only in Chinese on www.eastmoney.com, a major financial portal in China. The original web page written in Chinese is shown in the first picture below, with the total amount in RMB is highlighted in a blue rectangle. An English version of the page is shown in the second picture below, with the amount and the time span underlined in blue. We used Baidu’s engine to translate the page from Chinese to English (to preserve its “integrity” and “authenticity”), and the engine surely is far from perfect. For example, in the translated English page the phrase “nearly June” actually means “the last 6 months” in the original Chinese page.
Screenshot 1: Foreign Capital Inflow To Chinese Stock Market Over Last 6 months (Original Chinese Page)
Screenshot 2: Foreign Capital Inflow To Chinese Stock Market Over Last 6 months (English Translation)
The end result of capital flow from the U.S. and other countries into mainland China is this: Chinese stocks have performed better than their American counterparts so far this year. As the following table shows, both Shanghai Stock Index (China’s version of S&P 500) and Shenzhen Stock Index (China’s version of Nasdaq) have lost less ground than their U.S. counterparts since the beginning of this year.
Chinese stock indices’ outperformance over American ones is even more glaring and hard-to-believe considering the fact that China’s central bank has been easing over the past 3 months (with the benchmark rate in China now at decade-low level, see the news here and here) while the Fed has been tightening for the first time in many years. For as long as people can recall, U.S. dollar always appreciated against all currencies when the Fed raised benchmark interest rate because most investors think that U.S. bonds become more attractive due to higher rates and U.S. equities also become more attractive compared to equities in other countries because foreign companies will suffer bigger drops of net profits when borrowing costs in the U.S. rises. Many researchers and columnists have published literatures about the dollar’s dominance against other currencies and its safe-haven status. Readers who are interested in this topic can read here and here.
The aforementioned phenomena may have felt shocking and hard-to-swallow for many Americans, but they are undeniable cold facts. However, this time around U.S. is probably not the safest harbor in many international investors’ heart; that title now likely belongs to China. Otherwise, investors wouldn’t have exchanged huge amounts of U.S. dollar to Chinese Yuan (thus making dollar depreciated so much against Yuan) to bought huge amounts of Chinese stocks as we covered earlier in this article. So, why o’ why the great America lost in the competition of earning global investors’ hearts this time around? Why do more investors in the world think Chinese economy and companies will fare better this time around? Through careful reasoning and fact-checking, we offered two plausible explanations.
Firstly, Chinese economy did perform the best in nominal and real terms over the past decade, two years, and likely this year and at least the next couple years. Numbers don’t lie! Take a look at the following table.
Data Source: United States (USA) GDP - Gross Domestic Product 2021, Consumer Price Index Data from 1913 to 2022 | US Inflation Calculator, and publications of Center for Statistics in China.
In either nominal or real terms GDP/CPI, China outperformed the U.S. for the last three years by a wide margin, and the margin became bigger by years. More importantly, with China’s central bank now easing and pumping money to keep its growth engine and no sign of inflation in the country as last batch of data suggested, China’s real GDP growth is expected to keep strong feet in 2022. On the contrary, with inflation seemingly out of control in the U.S. and the Fed scramble to raise rates big time this year, a maneuver that inevitably will cool down economy, Americans’ real GDP growth looks far less promising in 2022.
One likely underlining force behind China’s relatively superior economic performance is its much better control (or “contain”) of COVID. According to WorldoMeter website, as of March 6th, the U.S. has had 81 million infections and close to 1 million death cases while China only has had 110 thousand infections and 4,636 death cases of COVID. As a result, China’s economic activities, especially those in manufacturing and construction sectors, recovered quickly back to pre-COVID level in the second half of 2020 and has stayed strong since, and China’s production and transportation of raw materials (iron, coal, aluminum, silicon, etc.) and foods also went back to normal just several months after the first COVID outbreak. Because factories in many parts of the world are still down or partially down, consumers rely more heavily on Chinese manufacturers for goods today than two years ago. In addition, because the supply of raw materials and foods is strong and smooth in China and because Chinese government did not inject huge amounts of money into its economy either through monetary or fiscal means in the last two years, inflation in the country is very tamed right now.
Although the Fed may be able to lower the inflation in the U.S. by raising rates significantly, the reward came with a high risk of significantly slowing down U.S. economic activities. In other words, the Fed is facing a dilemma between high GDP growth and high inflation, while Chinese central bank does not face such a dilemma. In our opinion, China’s situation today is similar to the U.S. situation in the 1990s, when strong increase in production per capita, not increase in monetary base, supported fast economic growth while keeping inflation at bay (ex-Fed chairman Greenspan’s famous “conundrum”).
If China’s higher real growth outlook is not enough to swing some investors from American assets to Chinese ones, another equally strong reason – China’s lower geopolitical risk – is also persuading them to do so. Most people in the world know that the U.S. is much more deeply involved and tangled in the Russia-Ukraine conflict than China is. Before the conflict finally became a formal war, the U.S. already was playing tough and bitter finger-printing with Russia on Ukraine issue (see this report for just one instance).
Then, after the war erupted, U.S. has made itself deeply tangled into the war by sending weapons to Ukraine and launching full-fledged economic sanctions on Russia, including seizing Russian citizens' assets, banning on imports of Russian goods, and kicking Russian banks out of SWIFT. Many economists warned that these heavy-weight economic sanctions are double-edged swords. They not only will make dramatically negative impacts to the economy of Russia but also will harm the economy of the U.S. For instance, the sanctions likely will significantly push prices of oil and gas in Europe and the U.S. upward (price rises are already evident just 10 days into the war) and make Russia and some other countries more determined to develop and use alternative systems and currencies for international trades, eventually diminishing the de-facto monopoly status U.S. dollar and SWIFT currently enjoy in international businesses. As the author in this article points out: “A rupee-rouble trade arrangement may get a push now that Russia is out of SWIFT …. China will presumably likewise increase its yuan-ruble trade with Russia.”.
In comparison, China has played a neutral card right from the beginning of the war, not leaning to either side or making premature or subjective judgment on either Russia or Ukraine is the most righteous in the confrontation. When the UN security council voted on condemning Russia in late February, China abstained, again not leaning toward the Ukraine or Russia (India and UAE also abstained). Not surprisingly, China also has not joined U.S. and EU’s big sanction wagon and thus is suffering little negative impact of the war on its economy. The only impact Chinese economy has felt so far is a moderate rise in imported oil price, but for this one, China also fares much better than the U.S. because they have no intention to cut oil supply from Russia. The glaring contrast between China’s neutral stance and the U.S.’ full-engagement stance has not gone unnoticed in the eyes of investors all over the world. Consequently and naturally, many global investors regard China and Chinese economy/capital market as geopolitically less risky than the U.S. and American economy/capital market right now.
For all investors in the U.S., the most important conclusion from all of the above thought processes we have went through is this: the capital market of China is offering a higher growth/risk ratio than the capital markets of the U.S. and most other countries this year and probably over next several years. Therefore, an unbiased and prudent asset re-balancing strategy for most American investors right now naturally involves increasing of stakes in Chinese stocks and decreasing of stakes in American stocks. A tougher decision is what Chinese stocks to invest in now. We offer our readers several plausible choices.
As we said in the beginning of this article, for most Americans, the best way to participate in the growth of the Chinese economy is investing in a China-oriented ETF fund. This way, an investor does not need to hand-pick individual stocks and will enjoy the benefit of diversification across a decent basket of stocks. In this group of ETFs, The China Fund is probably the best choice due to the breadth of its portfolio coverage and its long-time track record of strong performances. The fund invests in a wide range of companies across numerous sectors listed in mainland China, Hong Kong, and other markets (see details in the following tables).
Table: The China Fund Asset Exposure and Allocation
As we can see clearly in the following chart, the fund’s NAV (net asset value) has enjoyed a strong and stable upward trend and has grown nearly 20 folds since its inception. The track record is a proof of its management team’s superior investment knowledge and stock picking capability. The fund’s NAV has pulled back from its all-time high reached last year and is now close to the lower bound of its long-term upward price channel (the area between the two green lines in the chart below). Thus, this is probably a good entry point as the fund’s NAV has a good chance of reversing the downward trend and start moving upward again.
Chart: Long-Term Trend Of The China Fund NAV
For some seasoned and resourceful investors who are willing to spend extra time and energy to research and find the best individual Chinese stocks, the best choice is to invest in companies listed on China’s domestic stock exchanges (Shanghai exchange and Shenzhen exchange). Why? Because with over 5,000 companies to pick, by law of large number in statistics, the chance of finding the best deal is higher when the population is bigger. A perfect example of domestic Chinese companies offering exceptionally high reward/risk ratios that investors cannot find elsewhere is Lianchuang Optoelectronics (Lianovation, Shanghai stock exchange symbol 600363), the high-tech stock we covered in our blog posts (e.g. this one and this one). The company offers investors two-birds in one stone super combo deal: a super-high growth potential (60%+ compound annual net-profit growth rate for the next 5 years) combined with very low downside risk for this year and the next several years. Sitting on just 25 times of last year’s net profit (using consensus average from 6 analysts) and a small market capital of $1.7 billion, Lianovation truly is a screaming buy and a diamond selling for the price of a stone right now. Investing in Lianovation right now is equivalent to Warren Buffett’s investment in BYD in 2008 when BYD was at its young age and only a tiny fraction of its current size (needless to say BYD did give Buffett a mega return on investment). Because Lianovation’s cutting-edge technologies and products are desperately needed to upgrade the manufacturing processes of various industries and improve in equipment used in some very important sectors, including medicine and aerospace, and because all of its customers and suppliers are within China, whatever Fed wants to do or however serious the war between Russia and Ukraine become has minimum effect on its strong growth rates of top and bottom lines in either short or long term. In fact, if energy prices are pushed up significantly and energy-saving becomes even more important to Chinese government and manufacturers (it already is the nation’s top priority as it aims at becoming carbon-neutral by 2060), the demand for its high-temperature superconducting machines, which enjoy 50%+ energy-saving over most machines currently used in factories in China and other countries, will become even stronger.
Take Bank of Hangzhou (Shanghai stock exchange symbol 600926) for another example of domestic Chinese stocks with high reward/risk ratios. BOH is located in Hangzhou city, home to two of China’s most famous tourist attractions West Lake and Lingyin Temple (Temple of Inspired Seclusion). It is also a shopping-heaven where Alibaba’s headquarter resides. Moreover, the entire Zhejiang province, in which Hangzhou resides, is a neighbor of Shanghai and one of the most advanced and commercialized provinces in China. Readers who are interested can read a detailed description of Hangzhou on this page and complete introduction of BOH on this page.
Needless to say, a mid-size commercial bank in such a city and province has a huge room for future growth. To wit, over the past 5 years, Bank of Hangzhou grew both its top and bottom lines at about 20% compounded annual rate. With such a high speed of growth, the bank is trading at a low P/E ratio of 9 and offering 2.5% dividend yield based on today’s price. Where can one find such a high-growth plus high-value stock in the U.S.?
Unfortunately, we understand that not every American institution has a QFII (Qualified Foreign Institutional Investor) brokerage account in China, and not every American investor has a brokerage or bank account in Hong Kong to trade mainland China stocks via Hong Kong-Shanghai or Hong Kong-Shenzhen Stock Connect. For those who just are not able to buy China’s domestic stocks, the next best choice is to carefully pick and invest in the best Chinese companies trading on NYSE or Nasdaq. Because this group of stocks has depreciated so much over the past decade due to many reasons, there are some good deals among them for long-term investors.
Take Alibaba (BABA), arguably the most famous Chinese company and the trademark Chinese stock listed in the U.S., for example. Buffett and Munger do not still hold a huge stake in Alibaba for no good reason. The Internet superpower’s stock now is trading at miserable three-tenths of its all-time high reached just one and a half years ago; that’s a gigantic drop for a big cap by any standard. While Alibaba did face some quite tough headwinds last couple years and saw quite serious drops in net profit in last two reporting quarters, it is still the biggest online retailer in China. Most Chinese are still buying tons of goods on its shopping sites every month. Trading at a TTM P/E ratio of merely 26 and P/B ratio of merely 1.75, it is definitely a deep-value play in e-commerce sector if not yet a growth play for the moment being. With online shopping still growing at a fast clip in China, one can safely expect Alibaba’s top and bottom lines to resume at least a moderate speed of growth in the not too distant future. As such, Alibaba likely will come back to be a growth play again sooner or later. If you like Alibaba and are considering putting some serious stake into the stock, you might want to consider also putting some money in Tencent Holdings Limited (OTCPK:TCEHY), the second-largest Internet company in China, for some minimum diversification. Although Tencent overlaps Alibaba in some businesses such as e-commerce, a significant portion of its revenue comes from areas that Alibaba doesn’t touch, such as mobile gaming and chatting. Therefore, Tencent’s revenue and net income may rise when Alibaba’s drop and vice versa, pushing down the volatility of your portfolio.
Take PetroChina (PTR) for another example. Warren Buffett bought PetroChina in 2003 for an average price between 20 to 30 dollar per share and close out the investment after 4 years for an eight-fold return. Amazingly, almost two decades have passed since Buffett’s first buy of PTR, and the stock is now back to just a little more than twice of what Buffett paid back then and has lost an astounding 80% of value from its all-time high. The stock’s continuous decline over the past 10 years is understandable and arguably justified because the growth of China’s oil consumption kept on slowing down due to a gradual yet continuous decline of the nation’s yearly GDP growth rate and its shifting to clean energy. However, regardless PetroChina is still the largest oil producer for the second-largest economy of the world, and it has grown multi-folds since 2003. So, just in a general sense, PetroChina stock is a defensive play and offers a margin of security today probably as high as it offered to Buffett back in 2003. Moreover, last year, the company’s net profit rose for the first time in a decade, likely signaling a reversal of the long-term downward trend of its financial results. The company’s outlook is even brighter this year as the price of gasoline has risen drastically over the past several months, and the rise is showing no sign of slowing down (thanking mostly to Russia-Ukraine war, of course). Therefore, like the stocks mentioned before, PetroChina is a value plus growth play at current juncture. The oil giant’s most recent financial data from Yahoo Finance is shown below.
To sum things up, unprecedented time calls for unusual actions, and the most daunting challenge calls for clear-headed and creative solutions. Objectively speaking, chance is high that Chinese economy and companies do enjoy a higher growth/risk ratio than its American counterparts. For most Americans, whose personal wealth is almost 100% concentrated in American assets and stocks, addition of some exposure to China is probably a prudent maneuver. Because of the urgency of current global situation, a wise strategy for most people is buying some CHN shares as soon as possible to hedge geopolitical and Fed risks and then gradually move some money to few individual Chinese stocks after they have spent enough time to do due diligence and feel confident that certain companies have good chances of giving investors stronger long-term returns than diversified ETF funds can.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of LIANOVATION either through stock ownership, options, or other derivatives. 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: Disclaimer: The opinions of the author are not recommendations to buy or sell any security. Please remember to do your own research prior to making any investment decisions, as well as knowing your own unique goals and tolerance for risk.