Chinese stocks are the opposite of US Big Tech stocks in almost every way. They are cheap, but nevertheless unloved.
Those looking to invest in emerging markets can even choose a variant of emerging markets ex-China these days. Consequently, global equity portfolios hardly contain any Chinese stocks anymore. This means that just a little bit of good news can cause a sharp price recovery. The time has come to include more Chinese equities in portfolios.
That good news did not come from the Chinese People’s Congress last week, at least it seems that way. The growth target for this year is 5 per cent. That seems modest compared to the 10 per cent of yesteryear. The last time the Chinese economy grew 10 per cent was in 2010. Back then, China’s economy was $6 trillion. That is now $19 trillion. This means that at 5 per cent growth, the Chinese economy’s contribution to the global economy is twice as big as that 10 per cent growth in the past.
So every year, China now grows by the size of Switzerland or the Netherlands. Perhaps 5 per cent does not seem ambitious, but China’s real estate sector has shrunk by more than 60 per cent in a short time. Real estate and related services (excluding infrastructure) comprised more than 20 per cent of GDP until recently. In that respect, it is extraordinary that China is growing at all.
Extremely cheap
Chinese stocks are extremely cheap. Hong Kong, in particular, has several companies quoted below their net cash position. Chinese stocks are even cheaper than Japanese stocks have ever been. This is because even at the peak, Chinese equities have never been as expensive as Japanese equities, even though the price decline is similar to that in Japan from the peak. That price fall in Japan was the harbinger for the two lost decades. In that respect, Chinese equities seem to be pricing in an even blacker scenario.
The valuation of Chinese stocks is similar to that of US stocks during the Great Depression of the 1930s. For the record, the US economy shrank nominally by 50 per cent between 1930 and 1933. This was caused not only by problems in the real estate sector, but the entire US society was on the brink of collapse. Back then, it was quite normal to invest globally ex-USA. It also caused many investors to miss the Consumer Bull of the 1950s. As in China now, many investors then had no position in US stocks.
Still, 5 per cent economic growth is not yet enough for China. China is experiencing rising (youth) unemployment and even deflation. This is a direct consequence of disappointing consumption post-corona. Much of the savings are in one’s home and thus the housing market inhibits consumption. Moreover, in the communist salvation state, Chinese citizens have to provide good education, good healthcare and a good old age mainly by themselves.
So there is a need to save a lot. Beijing needs to stimulate the economy more, but unfairly fears Japanese conditions. Yet much of China’s economy is doing extremely well. The country is now the biggest exporter of electric cars and without China, the energy transition is not possible. The country is also growing fast in the field of semiconductors, a spearhead of Beijing’s Made in China 2025 initiative.
Disruptive innovations
Moreover, the Chinese government is also increasingly emphasising disruptive innovations. Not simply copying Western technology, but also developing new Chinese technology. Of course, this is not done by decree, but the Chinese know that this starts with basic scientific research and that is always a question of money.
The problems in China have been caused by the government. The zero-covid policy hit the economy hard and the property crisis was caused by the approach of the property developers. The positive side effect, however, is that the “moral hazard” problem in that sector has been addressed, which is how far the United States ultimately did not dare to go when Lehman fell.
Moreover, China also wants a strong currency so it is reluctant to cut interest rates ahead of the Fed. Only that has changed in recent weeks. Since the start of the Chinese new year, more and more liquidity has been flowing into the financial system. In the past, growing money supply was good for the Chinese stock market. A horsepower is also the buyback of own shares by Chinese companies and the Chinese government, which mainly helps to break speculative positions.
Gradually, Chinese consumers are also doing better. A major reason why those post-Corona did not travel en masse was because many pilots did not have sufficient flight hours to be allowed to fly. Given the travel movements during the Chinese New Year celebrations, Chinese consumers are now in a much better game. Meanwhile, it is also fair to say that the property market has now seen the bottom after three years of malaise. All indicators related to the housing market now point to recovery. These are all factors that investors in China could draw on.
Ownership
A sustainable recovery does require some reforms. Beijing is working on that. One sensitive issue is ownership in the communist country. The fact that companies quote below their net cash position is also because shareholders are uncertain whether this money will not eventually be nicked by the Chinese state.
Last Friday, the report of the Standing Committee of the 14th Chinese People’s Congress was released. This committee wants to build a “fair, law-based and orderly business environment, which will solve the challenges for private enterprises and fuel their endogenous motivational power and vitality for the accelerated development of new high-quality productive forces”. Xi even stated last Tuesday that the ‘growth of the private sector and private enterprises should be supported and the intrinsic impetus and innovativeness of various business entities should be boosted’.
For now, this is sufficient basis for a further recovery in China’s stock market. Even then, there will be plenty of investors who argue that they never want to invest in China because they have never made money on Chinese stocks. The same was true for investors in US stocks during the Great Depression, but things can change.
Han Dieperink is chief investment strategist at Auréus Asset Management. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co.