Assuming you are an investor with a long term perspective, one should definitely look at China as an investment opportunity right now. We should all know a thing or two about China and its future path of becoming a dominant country in the 21st century. And as contrarians we should all participate in this story as it unfolds. However, the best time to buy China is when others are bearish as they are today. This gives us a potential of better (cheaper) entry points as the country continues it secular rise towards more developed economic future.
Gauging sentiment isn’t always easy. Away from the fund flows, analyst recommendations and various surveys, on my last trip around Asia I really got to feel the negativity towards the China’s future economic prospects. Various trades, brokers, analysts and bankers I had a pleasure of meeting were all expecting disappointment from China in coming years (all but a handful I met in Singapore – you know who you are). One trader that works for a major investment bank in Hong Kong even told me that he was afraid that China could crash and end up being more of Pakistan or Zimbabwe, rather then the next great country.
The negative mood has been present all while earnings keep improving. The market traded at forward price to earrings ratio of almost 25 during the 2007 blow off top (please refer to Chart 4). This was one of the most expensive valuations in the last 15 years. At the same time, the 5 year rolling compound rate of return reached 50% (observe Chart 2 closely). In other words, Chinese equities were gifting investors a 50% return on average very year for the last 5 years into 2007. Wow!
These days the valuations are quite low, as the index trades just slightly over 8 times forward P/E. Furthermore, priced in US Dollars, Chinese stocks have been in a downtrend for 7 years now. This is a completely different story to the record breaking run of US equities since March 2009. So could the Chinese market now play catch up? Looking at Chart 3, we can see that some type of change could be taking place as the index attempts a breakout!
Chart 4: Russian equities are currently at incredibly cheap valuations!
Source: Ed Yardeni
Russian stocks, on the other hand, are even cheaper and for the obvious reasons too. The crisis in Ukraine continues to escalate, which is putting selling pressure on all Western and Eastern European stock markets. Growth has once again came to a grinding halt in Eurozone, while Russia is now most likely entering a technical recession. Sanctions are currently hurting both sides and for these reasons (and many others) Russian stocks have not entered a recovery mode like their Chinese counterparts (see in Chart 5).
At forward price to earnings ratio of below 5, which is usually only witnessed at major bottoms like 1998 / 2001 / 2008, I believe that Russian stocks a great investment prospect. And while we are on the topic of sentiment and negative outlook, Russia probably takes one of the top spots here. While Chinese stocks might be a buy right now, I would probably start purchasing Russian stocks on any future meaningful weakness.
Some of the indicators to look out for would be a further spike in Russian interest rates, as well as a collapse in both business and consumer confidence. Certain investors might question this and wonder why would I want to purchase Russian stocks if these major economic indicators deteriorate? After all, rising interest rates would hurt economic growth via falling profits and slower credit growth. At the same time, a collapse in confidence from both consumers and businesses indicates a major slowdown of economic activity.