INSIGHTS

On April 18, 2013

Pay Attention to Chinese Equity Market

Yesterday we had an update from the Chinese State Council on its near-term policy focal points. There were five points of focus:

• A focus on consumer policies with the goal of encouraging consumption as well as maintain the development of infrastructure such as transportation and roads.
• Insulate the agricultural supply base from stark price increases.
• Assist the improvement in overall welfare through employment, assist higher education for those in need, as well as support increased government housing.
• A multifaceted approach to taxing and pricing of resources, increase the facilitation of project approvals and continue to facilitate the service industries growth. They also wanted to “liberalize” interest rates.
• Monitor the credit risk and growth of debt for local government.

This follows the fairly progressive regulatory response recently given about the concern of the heating of the real estate market.

There has been significant press about the disappointing growth in the Chinese economy and rising concerns about the shadow banking increase of vulnerability. As such, the Shanghai composite has pulled back 10% from its highs, but remains up 12% from the near-term low set in early December.

By monitoring the market action in response to these macro concerns, it appears to us that a strong base has been set in for the market in general. Though there always is vulnerability to a developing market, it looks like the base is being formed with potential trading cycles occurring in the immediate timeframe. Consider the following price move over the last decade.

As one would expect in a country growing at 7%+ annually in GDP, the equity will have wild swings like playing an economic “Chutes and Ladders” game. In all fairness, the P/E (price to earnings) multiple will also oscillate and is only one of many measurements as to how much value an investment like this has. But take a closer look at the P/E multiples over the last 10 years and 20 years. The current multiple is trading at 53% of the 10-year average and 39% of its 20-year average.

The question, as we have been painfully and tragically reminded over the last week, is what is priced in and what isn’t? Terrorism and tragedy can never be priced in logically. In the case of China, it appears investors have long since discounted 7%+ growth in the overall economy as any aspect that warrants trading at a nearly 50% discount to its average multiple. Though there could be some more downside, it appears the overall pessimism is fully priced into the Chinese equity markets. For investors whose risk tolerance is warranted, a long-term investment in China and the BRIC (Brazil, Russia, India and China) countries in general looks to be as big an opportunity as has been given over the last decade. The story that is developing in the developing world is where most of the investments often sink or swim. It’s the gray area where art trumps science or metrics. Each individual country’s story must be scrutinized not with a jaded or domestic focus, but rather the contextual measure within each country’s strengths and weaknesses. By removing this “Western Bias,” stories often become a bit easier to understand and reveal many opportunities and risks missed by the mass of investors. With a stock market trading at 36% of its all-time highs, significant discount to earnings and a progressive and more broadly focused agenda, China at least deserves more attention than it is currently receiving, in our opinion. 

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.