Listening to the news, you wouldn’t know there was a bull market in Chinese stocks happening.
All you see are headlines about the U.S.-China trade war and how much U.S. President Trump’s tariffs are expected to damage the Chinese economy.
But Chinese stocks quietly climbed 32.7 percent from January 3 to April 19, 2019.
Since then, they’ve fallen11.5 percent. But they’re still up 17.3 percent from their lows in January.
The S&P 500 Index is up just 14.2 percent over the same period.
And I think Chinese stocks are about to go a lot higher…
Three reasons Chinese stocks could soar
1. Valuations are compelling
Back in February, I wrote about how a reliable indicator was signaling a 41 percent move up in Chinese stocks.
The price-to-book (P/B) value of the MSCI China A-Shares Index had fallen below 1.6 times.
For a market or index, the P/B ratio is the total market capitalisation of all the included listed companies divided by their total book value (net assets). The P/B ratio is a useful tool for valuing markets because it relies on book value, which is more stable than earnings, and gives an indication of how much more (or less) an investor is paying relative to the underlying net assets.
Since 2010, the P/B value of the MSCI China A-Shares Index has gone below 1.6 times five times. And each time was followed by a large increase 12 months afterwards. The average increase was 41 percent.
So investors tend to buy Chinese stocks when the P/B value falls below 1.6 times.
Today, even after the 17.3 percent increase in China’s stock market, the P/B value of the MSCI China A-Shares Index is at 1.72 times – which means the market is close to becoming attractive again to value-driven investors.
Meanwhile, another valuation – the cyclically-adjusted price-to-earnings (CAPE) ratio – is also indicating China’s market is undervalued. (The CAPE ratio uses real earnings over a 10-year period to smooth out fluctuations in corporate profits that occur over different periods of a business cycle.)
China’s CAPE ratio of 16.4 times is almost half that of the U.S., which trades at 30.6 times, and nearly a third cheaper than the world average CAPE ratio of 24 times.
While China’s stock market has been weak since Trump restarted the trade war last month, valuations are reaching a point where investors are starting to look for bargain opportunities. That’s bullish for the market.
2. Stimulus is kicking into high gear
Beijing has been busy implementing a stimulus programme designed to help the economy weather the trade war storm.
It includes freeing up funds banks can lend out to borrowers and consumers through reductions in the reserve requirement rate (RRR).
The RRR is the percentage of total deposits that the nation’s banks are required to keep in reserve and not lend out. The less money that banks have to keep in reserve, the more they can lend – which boosts economic growth.
That amount of reduction in the RRR frees up an estimated US$300 billion, which can be used for new loans.
Beijing also cut the value-added tax (VAT) on key industries, including manufacturing, by as much as 3 percent.
Then on June 11, China’s finance ministry said it would ease restrictions on the spending of proceeds from bond sales by local governments, allowing more money to flow into infrastructure-related projects.
3. The full impact of MSCI inclusion hasn’t been felt yet
As I’ve written about before, MSCI is quadrupling its weighting of Chinese stocks in its global indexes. MSCI is one of the top providers of indices for emerging markets. An estimated US$14 trillion of assets are benchmarked against these indexes.
The announcement in March to hike China’s weighting in the MSCI indexes is expected to result in as much as US$125 billion of funds flowing into 448 selected Chinese-listed stocks.
This weighting change is going to happen over three phases, the first of which happened on May 28. That doubled the inclusion rate from 5 percent to 10 percent.
Two more phases will take place this coming August and November – eventually doubling the inclusion rate to 20 percent.
These staggered MSCI inclusion phases will act as a steady, rising tide that lifts the Chinese stock market.
That’s why I expect the Chinese bull market to continue.
If you want to set yourself up to profit, a popular vehicle to invest in China A-Shares that trades on the Hong Kong exchange is the iShares FTSE A50 China Index (Exchange: Hong Kong; ticker: 2823).
It tracks the performance of 50 of the largest Chinese companies that trade on the Shanghai or Shenzhen exchanges. It’s currently up 23.6 percent year-to-date.
Singapore also has the United SSE50 China ETF (Exchange: Singapore; ticker: JK8), which tracks 50 of the largest China A-shares. It’s currently up 18 percent since the start of the year. But the trading volume is low, so be careful if you buy and sell.
Editor, Stansberry Pacific Research