Three reasons to like Chinese stocks

by Russ Koesterich, CFA, Portfolio Manager, Blackrock

Russ explains why Chinese equities should still be a core holding.

COVID 19 is first and foremost a health crisis, but it is fast becoming intertwined with long-standing political disputes. Most recently the focus has shifted to China, and the potential for an imposition, or re-imposition, of tariffs. But while China continues to be more exposed to political winds than other parts of investment universe, Chinese equities are still worth holding.

I last discussed China in January. At the time I suggested that Chinese shares looked cheap, relative to both global equities and other emerging markets. In an absolute sense, the call was, to say the least, ill-timed. But while China was initially the epicenter of the crisis, in recent months Chinese equities have beaten global equity benchmarks. On a three-month basis the S&P 500 Index is down nearly 15%. In contrast, Chinese domestically listed stocks and Hong Kong listed H-Shares are down 6% and 7.5% respectively. While Chinese equites are now at risk given renewed tensions, if today’s rhetoric proves to be just that Chinese equities look interesting. Here are three reasons.

Profitability

Last year’s preference for quality has only increased. This is not surprising given that a significant portion of companies will be lucky to survive the crisis, let alone turn a profit. In this environment it is worth highlighting that Chinese companies are increasingly among the most profitable in the world. My colleague Isabelle Liu just completed an analysis of global companies ranked by profitability, defined as return-on-invested-capital (ROIC) minus weighted average cost-of-capital (WACC). China now ranks second to the U.S. (see Chart 1)

Stocks are reasonably priced

U.S. stocks may score higher on profitability than their Chinese counterparts, but they are also much more expensive. Chinese equities trading on the Shanghai exchange are valued at roughly 11x FY1 earnings. Companies listed on Hong Kong’s exchange are trading at slightly above 8x earnings.

First-in-first-out

As China was the first country to be devastated by the virus, it is also the first to start to recover. While investors should always be a bit skeptical of Chinese economic data, there are credible signs that their economy is slowly beginning to improve. Currently China is about the only place in the world where manufacturing surveys are positive, indicating a tepid expansion.

On the brink, or a war-of-words?

The obvious caveat to the above is, as it has been for most of the past 2 ½ years, politics. What was originally a trade dispute with the United States has metastasized into a broader strategic conflict, a conflict now inflamed by questions around China’s handling of the early stages of the crisis. Should tensions mount, which is not difficult to imagine in an election year, Chinese stocks are vulnerable. However, if the recent rhetoric out of Washington turns out to be mostly election year posturing, investors should give Chinese equities another look.

Russ Koesterich, CFA, is a Portfolio Manager for BlackRock’s Global Allocation Fund and is a regular contributor to The Blog. 

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This post was first published at the official blog of Blackrock.