Chinese stocks have traded at a discount to global peers for over a decade but have rarely been cheaper than they are now.
Bearing in mind the myriad risk premiums investors must consider when investing in China - regulatory, economic, exchange rate and political, to name a few - there’s every chance they could get cheaper still.
Those with a higher risk tolerance or belief that China will soon replace the United States as the world’s most powerful economy may disagree. But Chinese assets are underperforming for a reason. Lots of reasons.
The gap between U.S. and Chinese equity valuations is the widest since March last year, and one of the widest in over 20 years.
According to comparable MSCI data, U.S. stocks are trading at 19.8 times 12-month forward earnings, almost twice China’s 10 times multiple. And that gap of almost 10 points has doubled in the past year.
The fact that U.S. equities are more expensive than Chinese stocks is nothing new. In the past two decades, that only really flipped during the 2007-2009 Great Financial Crisis. Since 2010, U.S. stocks have been at a consistent premium by this measure.
Reversion to mean would see the current gap shrink to around 4.5 points, but past results are no guarantee of future outcomes. This also applies to the relative stock market performances so far this year.
China’s blue chip equity index is down around 1% year to date, while the S&P 500 and Nasdaq are up 18% and 35%, respectively. The NYSE Fang+TM index of U.S. mega tech stocks is up 75%.
Again, that gap may suggest some rebalancing is overdue. The same could also be said for China’s relatively weak growth recovery so far this year - even as it continues to disappoint so many early year bets on a post-lockdown boom.
But hope makes for a difficult strategy. At minimum, investors will need clearer evidence of a turnaround in China’s economic and market conditions before moving back into its equities in any great size.
SLOW TRAIN COMING
The divergence between the world’s biggest two economies this year has widened dramatically, and not in the way many observers might have expected after COVID-19 restrictions in China were suddenly lifted in December.
The U.S. could be heading for a “soft landing” - no recession despite the most aggressive interest rate hiking cycle in 40 years - while Beijing is battling to shore up historically anemic growth, ward off deflation and prop up its currency.
Citi’s economic surprises indexes reflect this well - U.S. surprises are the most positive in over two years, while China’s are the most negative in over three years.
Excluding the wild distortions and volatility around the worst of the COVID pandemic in 2020, U.S. economic surprises relative to China’s have rarely been more positive at any point in the last 20 years.
Of course, China is still a key engine of global growth. The International Monetary Fund estimates China alone will account for more than a third of world growth this year, more than double India, the next biggest contributor with 15%.
But on its own terms, China’s momentum is waning. The era of double-digit annual GDP growth looks to be over, and challenges are multiple and mounting.
Economists at Goldman Sachs, Citi, Bank of America and Societe Generale, among others, cut their growth forecasts this week after China’s disappointing second-quarter GDP figures.
Nominal annual GDP growth of 4.8% in the second quarter was lower than real GDP growth of 6.3%, a huge deflation red flag. Pinpoint Asset Management’s Zhang Zhiwei said this is the first time this has happened since comparable data became available in 2016.
Citi’s economists point out the implied GDP deflator of -1.5% would be the biggest deflationary impulse since 2009, and SocGen economists say the government’s already conservative 5.0% growth target can only be met if Beijing ramps up stimulus and policy easing measures.
Perhaps even more alarming than the weak GDP figures this week was the claim from Peking University professor Zhang Dandan that youth unemployment in China may be more than double the official 21.3% rate in the second quarter, and close to 50%.
If that is anywhere near accurate, Beijing will need stimulus of an altogether greater magnitude to revive its economy and keep a lid on potential social unrest.
With all that going on, it is little wonder investors prefer the relative calm and attractive returns offered by Wall Street.
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