29th November 2012
China has consolidated its role as one of the biggest engines of the world economy but since the financial crisis that has not translated into returns from its stock market.
In fact, pretty much the opposite is the case. Now broker and investment manager Hargreaves Lansdown is asking why, while growth has continued, returns have never materialised.
Hargreaves Lansdown’s senior investment manager Adrian Lowcock says that growth and returns are not entirely unconnected.
He says: “China along with the rest of Asia and emerging markets failed to decouple from the West, but because of the strong growth in the region, better financial strength of their banks and growing middle class growth remains positive. However it fell significantly from year on year double digit GDP growth to strong single digit growth. The drop in the rate of growth caused fears that the bubble would burst.”
Perhaps this is unsurprising when you look at the fundamentals. Prior to the financial crisis, the Chinese stock market was trading at a price to earnings ratio of 30, arguably a high level for a boom and definitely very high for a downturn.
Lowcock adds: “These levels assumed a continuation of double digit growth in the Chinese economy – unrealistic and unsustainable in the aftermath of the world’s largest financial crisis. As growth rates have fallen, expectations for China stock market performance have also come down and become more realistic – indeed many investors have turned away from the region because of fears of a hard landing."
As HL points out the PE ratio for China now stands at eight. The Shenzhen index has fallen a massive 55.4 per cent. It also notes that since global markets bottomed out in 2009, the index has returned a paltry 0.42 per cent. The wider Asian region has performed much better returning 80.84 per cent.
Lowcock says: “Much of China’s underperformance can be explained through a rebalancing of valuations. Prior to the crisis China was expensively valued, but it is now looking more favourable compared with other Asian markets.”
But Lowcock says that China is now looking more favourable. The change in leadership should mean political stability. The HSBC purchasing managers' index stands at 50.4 with anything over 50 suggested growth in manufacturing activity.
Lowcock adds: “Whilst one piece of information does not make a trend, we are seeing a general slowing in the rate of decline in growth in China and the future looks more positive.
"China will still remain sensitive to growth in the West which is likely to stay weak for years, however the Chinese economy has adjusted to this and with valuations at historic lows this looks like a good entry point. The challenge remains that economic growth does not necessarily translate to company profits and stock market performance. Investors are buying shares in an essentially Communist country where there is heavy state control over business so there is a lot of risk that requires compensation.”
“Whilst China looks cheap, investors are still shunning it at the moment, so it may get cheaper still. We like the valuations for China, but there is little choice for pure China funds and we prefer to offer a diversified approach to investing. We like First State Asian Pacific Leaders which has over 20 per cent of its portfolio invested in China and Hong Kong.”