Is China Cheap?

Don’t invest in China

Goldman Sachs’ wealth management CIO Sharmin Mossavar-Rahmani warned earlier this month. Her comments reflect bearish sentiment surrounding the country’s economy. 

China’s stock market has endured a tough few years. The elusive post-Covid bounce, property crises, poor demographics and geopolitical tensions all alarm investors. The country’s benchmark stock index fell 60 percent from early 2021 to February 2024. That’s more than $6 trillion in equity market losses. 

Investor darlings India, Japan and the USA have put China firmly in the shade. But recent bubble indicators means alpha seekers are looking elsewhere. Is China now cheap enough to be that source of value?   

INFLATION RISING 

Recent data supports that case. Inflation is finally rising with February’s figure of 0.7% representing its first advance since August 2023. Beating expectations, it boosted confidence that China can avoid the deflationary spiral many fear. And its stock market is showing signs of life again. It has gained 13 percent since those February lows.   

Sceptics call this a dead cat bounce and attribute the deflationary reprieve to the Lunar New Year holidays. But it may signal that China’s economic outlook is better than sentiment suggests. Its stocks are far cheaper on a valuation basis than anywhere else, the CCP has a clear strategy to pivot into high-demand industries and geopolitical tensions have been overexaggerated. 

China faces huge challenges but the reality is better than currently portrayed. Whether this is the start of a great bull rally or just the chance to get in cheap, its stock market is on the up. 

VALUE STOCKS

Hearing only bullish things on Japan, I messaged a trader friend for his thoughts. I was surprised by his outlook. With the Nikkei at all-time highs, he anticipated an imminent rate rise and retail investors fleeing its stock market in favour of bonds. The subsequently stronger Yen would challenge Japan’s export-driven economy.  

He is looking to China instead. Its stock market is full of value stocks trading at around 7-8 times earnings. Compare that to 20 and above for many stocks in the S & P 500 or Indian ETFs. 

This suggests China’s stock market is either undervalued or its growth prospects are poor. Louis-Vincent Gave says the data suggests it’s the former. He argues that falling bank share prices are an indicator of most financial crises. The S&P Composite 1500 Bank index fell 66 percent between January 2007 and July 2008 before Lehman Brothers collapsed in September that year. By contrast, Chinese bank shares are well up on December lows and otherwise consistent over the last 18 months. 

Gave also points to the performance of government bonds. From 2020 to mid-2023, long-dated Chinese government bonds returned 17.1 percent while long-dated US Treasuries delivered negative returns of 13.4 percent. Gave argues it is unprecedented for such a situation to herald a systemic financial crisis. 

“HIGH QUALITY DEVELOPMENT” 

The stellar performance of China’s government bonds continues today. Spurred by the flight from stocks, it nonetheless provides the government with cheap financing. The yield on the country’s 10-year sovereign note fell below 2.3 percent at the start of March. Investors bemoaning the lack of any big fiscal stimulus can see this provides capacity for action. 

Future spending will be targeted rather than a reckless splurge. The government emphasises a new era of “high quality development”. This means sustainable growth in high tech industries like Electric Vehicles (EVs), hydrogen power, chipmakers and automation. 

And the weakening US dollar as the Fed prepares for rate cuts is a double boon for this strategic vision. Not only will it further increase the attractiveness of Chinese bonds but it will also make Chinese exports more competitive. Its world-leading EV sector, for instance, will benefit as prices become increasingly attractive despite prohibitive tariffs.

ECONOMIC DECENTRALISATION 

Keyu Jin suggests players in these innovative sectors will benefit from China’s economic decentralisation. Jin argues that the country’s increasingly centralised politics do not reflect its economic approach. 

Despite Xi Jinping’s solidification of absolute rule, his economic strategy empowers local mayors and encourages competition between regions. Jin points to the distribution of unicorns around the country as evidence of its success. 

IS CHINA OPEN FOR BUSINESS?

Others are unconvinced this increasingly autocratic political regime can co-exist with a free-wheeling innovative economy. The scrapping of the Premier’s address at the recent National People’s Congress was another sign of China’s retreat into opacity.

Chinese Foreign Minister Wang Yi listens to a question during a press conference on the sideline of the National People’s Congress in Beijing, Thursday, March 7, 2024. (AP Photo/Ng Han Guan)

The country is sending different policy signals. Foreign minister Wang Yi argues “China remains strong as an engine for growth.” The economic blueprint he unveiled at the Congress plans to open up more areas to foreign investment. Yet Xi Jinping’s pronouncements on self-reliance suggest an increasingly autarkic regime prioritising security over prosperity. 

US-CHINA TENSIONS 

This haze extends to foreign policy. China is increasingly assertive in the region. Its claims on various islands are jeopardising relations with strong economic partners like South Korea. And defence analysts are split on whether a blockade, or even full-scale invasion, of Taiwan is a realistic prospect this decade.

But the global drift towards realpolitik suggests that, short of these actions in the Taiwan Strait, China is unlikely to be punished for its increasing militarism. Strong rhetoric has rarely been followed by tough action. Argentina’s Javier Milei quickly toned down his election campaign reference to China as an “assassin”. He soon backtracked on promises to end diplomatic relations. Likewise Australia has recently adopted a much more diplomatic stance as it seeks to end China’s tariffs on its wine. 

China’s economic might is such that even US allies are reluctant to be long-term partners in any punitive coalition. Instead, the current equilibrium can hold. Pincer movements like the Quad will deter China from the most egregious actions while it continues to test boundaries through military manoeuvres. 

That may not be as exciting as more dramatic predictions but James Mackintosh argues it reflects market sentiment. Apple is his case in point; a stock hugely intertwined with the Chinese economy. It relies on China for 20 percent of its sales and for much of its manufacturing. Yet it trades at 29 times forward earnings. Investors are either getting it wrong on Apple or China. 

NEW CHINA 

This China is not the growth powerhouse of earlier years. Its new incarnation rightly concerns investors as Xi Jinping’s nationalistic rule marks the end of Deng Xiaoping’s era of openness. But risk factors are over exaggerated and sentiment overly bearish. As Nvidia hype quells, investors should look east for value.        

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