Contrarian investing is one of the most popular investment strategies in the stock market (which of course is a contradiction). So it’s by definition misunderstood or misapplied by most everyone (we’ve talked about it here, here and here).
Buying when everyone else is selling, and venturing into hated markets, is scary. It takes a lot of courage to go against the herd.
Right now, the herd doesn’t like China.
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Fear is now gripping China’s stock market
While the Dow Jones and S&P 500 Indices are scaling new heights, China’s stock market has been among the worst performers in the world in 2018.
The Shanghai Composite Index has declined by 18.6 percent in 2018 so far. That compares with the 1.6 percent gain in the Dow Jones Global Index, a 6.8 percent decline in Hong Kong’s Hang Seng Index and a 3.2 percent drop in the Euro Stoxx 50 Index.
Concerns about a protracted trade war with the U.S. (see here and here) have hurt investor sentiment towards China and its economy. Recent threats by U.S. President Donald Trump to impose tariffs on an additional US$200 billion worth of Chinese exports will further rattle investors.
Then there’s China’s real estate market. And what’s more, superstition among investors here in Asia has in the past meant that they’ve stayed clear of the stock market during the “Ghost Month” that falls in August. Finally, a recent string of big IPOs that have fallen flat hasn’t helped.
As a result, China has become today one of the most hated markets in the world.
The chart above shows the Shanghai Composite Index since 2002, along with the percentage of stocks that are in the index whose shares are trading above their 200-day moving average. That’s a key indicator used by traders for determining long-term price trends – that is, whether a share is generally headed up, or down.
As the percentage of stocks on an exchange trading above their 200-day moving average approaches 100 percent, it often means that that the market is nearing a top. As the percentage of stocks trading above their 200-day moving average approaches zero, it signals extreme bearishness – and suggests that a bottom is near.
Right now, only 7 percent of the stocks in the Shanghai Composite Index are trading above their 200-day moving averages. That’s the lowest level in 2.5 years, indicating that buying sentiment is extremely weak.
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China is doing all right
Of course, weak sentiment doesn’t assure that prices will start rising tomorrow, or anytime soon. Weak sentiment can always get weaker.
But if fundamentals haven’t changed, that turnaround may happen sooner rather than later. And little has changed in China so far as its economy is concerned. It’s still growing by at least 6.5 percent per year, driven by strong domestic consumer demand, booming infrastructure spending and a resilient property market.
Steel prices, a traditional key indicator of economic activity, have climbed 22 percent in China since the start of the year. Air travel domestically is still growing by double digits. And while retail sales growth of 8.8 percent is slower than last year’s, it’s still faster than growth in retail sales of any other major economy in the world.
China’s government has also shown that it will do just about anything to meet its growth targets, which it views as critical in maintaining social stability and confidence in the economy.
That includes stepping up a debt-fueled investment expansion, as it has done in the past, to mitigate any slowdown in its export-driven manufacturing sector – which accounts for 40 percent of the country’s gross domestic product.
This will likely result in further deterioration of China’s long-term debt profile. The country’s total debt-to-GDP ratio stands at 300 percent – similar to developed nations such as Italy, South Korea, the U.K. and the U.S. That’s about double where it was 10 years ago.
But this needs to be taken in the context of a tripling in the size of China’s economy over the same period in local currency terms, from 27 trillion yuan in 2007 to 82.7 trillion yuan last year. As long as the economy hums along at a rate that nearly doubles its size in the next 10 years, and its real estate market holds steady, China will remain a big opportunity.
Legendary investor Jim Rogers (who we’ve interview ourselves and talked about here, here and here) has made hugely profitable contrarian calls in the past. In a recent interview with BusinessWorld this week, he continues to be bullish on industries with Chinese government support, including those dealing with environmental cleanup, healthcare and agriculture.
Like us, he understands that the long-term trend of growing Chinese travel remains intact and strong, and that the Belt and Road Initiative will continue to generate enormous opportunities for investing in related Chinese stocks.
The recent correction in Chinese shares, while painful today, will likely soon go down again in history as just that – another correction that paves the way for bigger share price gains going forward.
Editor, Stansberry Churchouse Research