Chinese stocks are cheap – but for good reasons

Chinese stocks are trading at an “undeniably cheap” 11.9 times earnings. But they are cheap for good reasons, and this may not be the buying opportunity it appears to be.

“For a market deemed on the verge of ‘uninvestable’ a few months ago”, China looks “pretty perky”, says Craig Mellow in Barron’s. The CSI 300 index lost 23% between 1 January and a low in April, but has since rallied 11%.

Without abandoning “zero-Covid”, officials have signalled a shift to a more “dynamic” approach that makes greater use of targeted testing and largely eschews draconian lockdowns of the type seen in Shanghai this spring. Stimulus is incoming, with the central bank easing lending conditions and another infrastructure splurge on the way. Crucially for investors, “regulatory assaults on internet companies have eased” – witness Alibaba’s 40% share-price gain since mid-March.

“Stringent Covid lockdowns” saw China’s economy contract by 2.6% between April and June, say Li Wei, Ding Shuang and Hunter Chan of Standard Chartered. Yet more recent data “points to a continued economic recovery”, with industrial production up 3.9% in the year to June, while the retail sector expanded by an annual 3.1%.

“We expect China’s economy to improve further in the run-up to the 20th Party Congress [this autumn] on increased stimulus and less disruptive Covid-control policies.”

The economy is not in the clear yet, says Ian Williams in The Spectator. A sagging property market “now threatens to spill over” into “a local banking crisis”, as shown by recent scandals at “provincial banks”. The sector is “heavily indebted” and “weighed down with bad loans”. That compounds fears over local-government debt worth an estimated 44% of GDP lurking in the opaque financial system.

The Nasdaq Golden Dragon China index, which tracks US-listed Chinese firms, lost 67% between February 2021 and June 2022, says David Brenchley in The Times. Is this a buying opportunity? Chinese shares have become “regarded as a pariah asset the same way energy was in 2020”, says Mike Coop of Morningstar Investment Management. Like energy shares, they could soon enjoy a renaissance. The MSCI China index trades on an undeniably cheap cyclically adjusted price/earnings (CAPE) ratio of 11.9.

Yet money managers now prefer to gain exposure to China via nearby regional markets or Western firms with operations in the country rather than by buying local stocks directly, says Sofia Horta e Costa on Bloomberg. “Even if you have a positive macro view on China, [it’s] hard... to sell Chinese stocks,” says Jamie Dannhauser of investment firm Ruffer.

Some European pension funds reportedly “no longer want China in their portfolios because of rising geopolitical and governance risks”. As Ruffer’s Matt Smith puts it, “the supertanker of Western capital is starting to turn away from China”.

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