CHINESE EQUITIES: CHEAP BUT…

This is from the respectable BCA Research. They use a value indicator that has worked reasonably well in the past 15 years and it is true that China has a well defined upward trend. Risk here is that China remains highly dependent from Western World economies where final demand is very weak. Secondly, China is fighting a stubborn inflation problem which carries two additional sets of risks:

  1. Inflation impacts valuation. So seemingly cheap markets may not be that cheap when higher inflation is factored in, which BCA’s indicator does not do.
  2. Inflation can be tough to reign in and necessitate longer and more radical economic measures. Beijing has clearly said that fighting inflation is its top priority at this point.

I would wait for signs that inflation is clearly tapering off before jumping heavily in Chinese equities.

Greater China equities will not be immune if another rout hits global risk assets. However, our China Investment Strategy team remains positive on Chinese domestic stocks.

Chinese A-shares have been following a well defined upward trend line since the inception of the market, consistent with the economy’s rapid ascendance, albeit with greater volatility. Currently, the market is once again standing at two standard deviations below trend, a level that has historically heralded major market bottoms. Unless the economy enters into a deep slump, we expect the long-term pattern to hold. In addition, all major equity indexes globally are arguably cheap following the recent selloff, but Chinese equities are particularly attractive given their growth potential. Our composite valuation indicator shows that A shares are currently at deeply undervalued territory, a level comparable to late 2008 at the height of the global financial crisis. Another supportive factor in light of volatile markets is that compared with other emerging market equities, Chinese A shares have little correlation with global bourses due to the country’s capital account controls. In other words, this asset class provides a “safe haven” amid global volatility.


 

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