Chinese Equity Valuations Getting Cheaper

I have been bearish on China, as well as the other hot growth areas like India, Russia, etc, for a while now. This meant I missed the huge gains over the last few years, but it also means I avoided the huge losses over the last 6 months (it's hard to invest in China and you are mostly limited to the stocks on the Hong Kong exchange, US-listed ADRs or OTC Pink Sheet stocks). Here is a chart showing what has transpired on the Shanghai and Hang Seng markets, with the S&P 500 shown for reference:

Note that this chart does not necessarily show if something is undervalued or overvalued. Valuations will initially be depressed in developing countries so even if they rise a lot, it doesn't mean they are necessarily overvalued. In the case of China, they were clearly overvalued (with P/Es above 50 last year) but it's not clear to me if others which rose a lot in the last few years, like Brazil, are overvalued. Bloomberg reports that equity valuations are getting cheaper and some strategists are finding Chinese stocks attractive:

(not quoted in order)

The 32 percent slump in China's CSI 300 Index, the steepest decline among the world's 20 biggest equity markets, narrowed the price-earnings gap with the Standard & Poor's 500 Index to 13 percent from 139 percent as of the end of last week. Mainland stocks traded in Hong Kong, where no foreign investment limits exist, are 23 percent cheaper than U.S. shares, data compiled by Bloomberg show...

Companies in the CSI 300 trade at an average price-earnings ratio of 26.4, down from a record 52.8 in October, weekly data compiled by Bloomberg show. That compares with a ratio of 23.4 for the S&P 500. The benchmark index for American equities last traded at a premium to the CSI 300 in March 2006.

Those valuations are not necessarily attractive. The high growth in China makes stocks attractive but I am uncertain about the sustainability of the high growth rates. Secondly, the valuations need to be discounted due to corruption, weak property rights, and questionable accounting. For instance, I recall reading an year or so ago that a sizeable chunk of the operating profits at some companies came from gains on the stock market. This is so eerily similar to how Japanese companies posted profits in the late 80's off gains on their real estate, which was in a bubble.

But many prominent investors disagree with me, with Mark Mobius being one who thinks that Chinese stocks are attractive now:

``The correction in China provides a good opportunity to get in,'' said Mark Mobius, 71, who oversees about $42 billion of emerging-market equities as executive chairman of Templeton Asset Management Ltd. in Singapore. ``Valuations of these companies are very attractive. There's no question that even if you downgrade China growth by a few points, it's still going to be greater than in the U.S.''

Jim Rogers is another investor who is bullish on China. One thing to keep in mind is that many of these prominent investors may be bullish because they are diversified into many other countries and/or they have a low cost basis. For example, someone like Jim Rogers has been bullish on China for years, while stating that there will be big corrections. If someone bought China late last year (close to the peak) on Jim Rogers' bullish views, he/she would be down almost 50% and needs a 100% rally from here to get back to even. If one is bullish I'm sure a 100% rally over the next few years isn't impossible but I wonder how many can hold until then. In contrast, those with lower cost basis from a few years ago can absorb the big decline. This is just a hypothetical argument since you can't really invest on the Shanghai market but it is important to take what someone says with some context.

Someone like Mark Mobius invests in many countries. While he is bullish on China, he may also be bullish on 10 other countries. Even if China doesn't work out, he'll be fine if his other bets work out. In contrast, if you were a concentrated investor like me, or if you heavily overweight China then you need to consider the full picture. I think it is extremely important to place greater weight on those who use tactics that are similar to you, on top of having similar strategies and thinking. For example, I consider myself a contrarian investor and highly respect David Dreman but I generally am very careful with his stock suggestions. David Dreman runs a highly diversified portfolio (I think something like 50 to 100 stocks) so if he likes Fannie Mae and it doesn't work out, he may still be fine. I'm trying to run a concentrated portfolio (still not sure that's what I should do) and if I bet on Fannie Mae and it doesn't work out, I'm screwed. If you are trying to develop some concentrated portfolio skills, the best investors to follow are Warren Buffett, Charlie Munger, Bruce Berkowitz, Mohnish Pabri, Seth Klarman, and Eddie Lampert (not in any order). Investors such as David Dreman, Martin Whitman, and so on, are highly diversified investors. If MBIA doesn't work out, Martin Whitman will still be fine; but not me :)

Tags: ,

1 Response to Chinese Equity Valuations Getting Cheaper

June 14, 2008 at 4:15 PM

Maybe trying a few concentrated ETF will do the job. Instead of buying an individual stock like MBIA, try an ETF that contains similar stocks like MBIA. If MBIA fails to survive, the ETF will survive.

By the way, there are a couple of ETF listed in Hong Kong that track China index like CSI 300 Index. So foreigners still could access the Chinese market 'A' shares. Though I dun it is time to enter the market yet,likely to fall to lower level in near future.

Post a Comment