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Spread Strategy Based On P/E Divergence Between China & U.S Equity Markets

China has enjoyed phenomenal economic growth since the mid-1990s but China's heavy reliance on exports now has to be supplemented by greater internal consumption. That's a far bigger ask as the same products sold for export are relatively more expensive when sold into the internal market. Although the signs are that inflation has not yet reared its ugly head in China, it is often a bedfellow of a sustained increase in consumer spending and has to be kept on the investment analysis radar. That said, if the assumption that the inflation figures are correct then we can most likely expect another rate cut in China around the end of the third quarter of this year.

Beware the sting in the tail. There are plenty of ifs and buts in China's economic mix, which clouds any investor's view about what may be around the corner in the next few months. For believers of the Chinese growth story the Hang Seng China Enterprises[^HSCE] index is trading on just 8 times estimated earnings compared to 13.6 and 11.6 for the S&P 500 (^GSPC) and the Stoxx Europe 600 respectively. With no real growth expected in Europe or the U.S in the visible future and China continuing to grow strongly, even if not quite as strongly as before, Chinese equities look undervalued. A potential trade can be to buy one of the main Chinese indices (e.g. Shanghai composite index) whilst taking a short position on the S&P 500, looking for P/E ratio convergence. There's very little evidence to suggest that Europe has hit the bottom.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.