We have ended the month of May and China stocks seem to be on track to record yet another year of underperformance when compared to the US market.
Most broad based Chinese indices in Shanghai and Shenzhen are down single digit percentages YTD. Hong Kong indices are slightly worse off with the Hang Seng Index down nearly 10% and the Hang Seng Tech index down slightly more than 10% in the first five months. On the other hand, the Nasdaq has had a remarkable 25% YTD performance while the Dow Jones is flat.
Investors must be wondering whether you should buy, hold or sell China stocks.
Here let’s discuss reasons for each case to help elucidate each individual investor’s thought process.
4 Reasons Why You Should Buy China Stocks
1) Low valuations
The valuation of China’s stocks is significantly lower than the developed world both from a current and forward ratio perspective.
For example, the Chinese and Hong Kong indices are trading at a high single digit P/E ratio of while the Nasdaq and S&P500 index are trading above a P/E of 20.
The fact that Apple the biggest stock by market cap in the US is currently valued at $2.8T, bigger than all companies listed in other large countries such as Germany, United Kingdom, France and India further illustrates the valuation disparity.
2) Long term macroeconomic tail winds
In a polarizing world with a two speed economic growth, S&P Global forecasts:
- China’s potential GDP growth to average 4.4% till 2030
- the US and other developed western economies are not expected to grow more than 2.5% in the medium term
Some economists even forecast for the possibility of recession in 2023 and 2024.
3) Portfolio allocation
Portfolio allocation is all about diversification, balance, and comfort levels. The benefit of investing a certain portion in China stocks are its strong potential growth.
In November 2020 (before US/China relationship took a turn), the portfolio advisory team at Willis Towers Watson noted that investors globally held less than 5% of their portfolio in China and suggested an allocation up to 20%.
He also noted that if you believe that the world is moving away from globalization or if you believe that the major economies in the world, particularly the US & China will decouple from each other, then there’s a strong case for allocation into China.
More so if the decoupling does not happen as quickly or rapidly.
4) Regulation is positive
One perspective of China’s regulation is that the goal isn’t to destroy all of its fastest-growing companies but merely to manage them, protect workers’ rights, and ensure they aren’t monopolizing user data or entire industries.
In other words, China believes it can trade some short-term pain for stable long-term gains.
This should bode well for the future of China stocks.
2 Reasons to Hold China Stocks
1) Mean reversion
Benjamin Graham, the economist widely known as the father of value investing once said ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’
As long as fundamentals are intact or improving, mean reversion will likely occur over time.
2) Portfolio allocation
For investors who have already have positions in Chinese stocks and are regarded as appropriately diversified, it could be worthwhile taking a long term view, if you agreed with my reasons to buy.
Otherwise, refer to the next section.
4 Reasons to Sell your China stocks
1) Worsening Geopolitics
China is regarded as the only large economy to make it from third world to first. China’s economy is now the second largest in the world.
With many economists predicting that the size of China’s economy will overtake USA in the next few decades as China’s growth rate exceeds the US, the US has taken a protectionist and aggressive approach in trying to stay ahead vs China.
The US has implemented tariffs on a vast range of sectors, ban exports on key advanced technologies and attempted to gather their allies against China. There are views that the China and US may walk into a conflict due to the potential for various situations to escalate quickly.
2) Regulation is an anchor to stock prices
China has on multiple occasions carried out escalating and unpredictable regulatory crackdown on all sectors to varying extent. For sectors such as Tech, some fear that growth may have been stifled for a good period while for sectors such as online tuition education, the industry has been completely decimated.
Regulatory actions can be merely procedural and in the long term interest of the parties concerned. However it is difficult to control the narrative and the actual impact to individual companies. In addition, investors may not fully understand the immediate and longer term impact of each regulatory action and may choose to completely avoid such situations.
3) Portfolio allocation
For investors who believe that there should be no allocation to China, it is best to sell if they have not already.
4) Volatility in Chinese stocks
Some market watchers believe that the higher volatility in Chinese stocks are due to a few factors such as its emerging market status and the lower percentage of institutional funds as well as market makers.
To compensate for this higher volatility on a portfolio basis, investors will either demand a higher premium (i.e., lower price of entry) or reduce exposure to Chinese stocks.
Closing statements
At the end of the day, the decision on whether to buy, hold or sell China stocks depends on your perspective on a few key matters such as valuation, geopolitics and other macro factors.
For those seeking to have a well balanced portfolio and diversify, China’s stocks is one to consider buying a suitable proportion or holding to their current positions.
However if you believe that Chinese stocks are uninvestable regardless, then it is better not to own any Chinese stocks. The most important thing for an investment is that it will allow you to sleep well.
Alternatively, you can also gain exposure through the best China ETFs.
