China’s stock market hasn’t been keeping up with the country’s economic growth. So far this year, the Shanghai Stock Exchange composite index is down 4.3 per cent and it touched a three-and-a-half year low in late September.
Yes, economic growth is slowing, but only in relative terms: In the second quarter, gross domestic product expanded by 7.6 per cent. The Economist put it this way: The benchmark index is essentially back to where it was 12 years ago, a period that has seen the country’s GDP rise four-fold in nominal terms.
But as China prepares to report GDP growth for the third quarter on Thursday, Vincent Chan, head of research and strategy at Credit Suisse, argues that the economy may have bottomed out – and that means stocks could see big gains ahead.
“After almost two years of caution, we believe that most market concerns of a structurally weaker growth for China are being discounted,” he said in a note. “We have not changed our fundamental view on China though – we expect the structural growth momentum to be weak and do not expect the pace of recovery to be strong.”
He sees six signs of stabilization: Infrastructure investments are picking up, retail sales growth is stabilizing, business sentiment indicators point to improvement and housing starts, loan growth and machinery sales are bottoming out.
For sure, this isn’t a popular view, with some market watchers still worried about a so-called hard landing there. Indeed, Mr. Chan believes that China is probably the world’s most “unloved” market right now, given that hedge funds continue to steer clear of the country even as they jump back into Asian peers like Taiwan, India and South Korea. But their lack of interest has left Chinese stocks looking tempting from a valuation perspective.
Mr. Chan said that valuations are back to 2008 levels – after stocks had fallen with the global financial crisis – in price-to-book ratios and the earnings yield gap, which compares stock valuations with interest rates.
Accordingly, he believes there is a 20 per cent upside to Chinese stocks even if earnings don’t rise.