Image Credit: Christophe Vorlet
By Jason Zweig | May 29, 2015 7:42 p.m. ET
If this past week’s stumble in Chinese stocks has you thinking about buying, think twice.
On Thursday, the Shanghai Composite Index fell 6.5%, the Shenzhen Stock Exchange Composite Index lost 5.5% and the Hang Seng Index of Hong Kong-listed stocks dropped 2.2%. They changed little on Friday.
Speculative frenzies don’t become safe just because there is a momentary pause in the proceedings. U.S. investors should shop carefully in China—if at all.
Even after the selloff, the Shanghai index is up 42.6% in 2015 and Shenzhen, 97.4%; neither figure includes dividends.
Stocks in Shenzhen are trading at an average of 61.4 times earnings, according to the exchange—nearly twice their level at the end of 2014 and almost 25% higher than where they stood on April 30. By price/earnings ratio, the Shenzhen market is more than three times as expensive as the MSCI EAFE index of international stocks; the U.S. is at about 22 times earnings.
The Shanghai and Shenzhen markets for so-called A shares are dominated by local amateur traders, using borrowed money, who have whipped up prices.
A year ago, the turnover rate—a measure of how fast investors are buying and selling, calculated by dividing total trading by the value of all listed stocks—was 98% on the Shanghai exchange and 204% in Shenzhen, according to the World Federation of Exchanges. By the end of April, turnover had risen to 600% in Shanghai and 706% in Shenzhen, meaning that local “investors” were holding the typical stock for less than two months at a time. This past week, daily turnover in Shenzhen hit 7%, implying that the average stock was changing hands every 14 days.
By contrast, the estimated turnover in the U.S. was recently about 300%, indicating that the average stock would change hands every four months or so.
With the real-estate market slowing, the Chinese government has made a bull market in stocks part of its agenda for economic stimulus, says Cheah Cheng Hye, chairman of Hong Kong-based Value Partners, one of Asia’s largest investment managers, with $17 billion in assets. That includes a forthcoming stock-trading link between Shenzhen and Hong Kong, which will complement the link between Shanghai and Hong Kong established last year.
“If you bet against Chinese stocks, you’re betting against what Beijing wants,” Mr. Cheah says.
And there are reasons to be optimistic in the long run; it is China, after all. Helen Zhu, head of Chinese equities at BlackRock, the world’s largest investment manager, says economic growth is “just stable enough to provide an adequate foundation of stability,” enabling the government to pursue “structural improvements that would underpin further returns.”
Both Mr. Cheah and Ms. Zhu are generally bullish. “Chinese stocks still have a lot of catching up to do,” Mr. Cheah says. “I believe we are only in the middle of a multiyear recovery.”
Shares listed in Hong Kong have been largely uncontaminated by the speculation that is driving Shanghai and Shenzhen, says Burton Malkiel, emeritus professor of finance at Princeton University and chief investment officer at Wealthfront, an online investment adviser in Palo Alto, Calif.
Hong Kong shares trade at approximately 16 times their long-term, inflation-adjusted earnings, he estimates—far cheaper than U.S. stocks, at about 27 times the same measure. “Despite the big rise in Chinese stocks recently, they don’t scream ‘bubble’ to me,” he says.
But investors should bear in mind that the epic expectations for Chinese stocks have yet to be realized. China has a history of bubbles and busts dating back to the 19th century.
And rapid national economic growth often doesn’t produce high stock-market returns, largely because it tends to coax investors into paying too much for stocks. From the beginning of 1993, when reliable data begin, through the end of 2014, Chinese stocks available to global investors have lost an average of 3.2% annually, after inflation, according to finance researchers Elroy Dimson, Paul Marsh and Mike Staunton of London Business School.
Even so, some U.S. investors have been chasing China’s recent hot streak. They have added $856 million to mutual funds and exchange-traded funds specializing in China so far this month and $2.7 billion in 2015, estimates TrimTabs Investment Research, a firm in Sausalito, Calif.
Those investors are likely to sell in a panic if the selloff continues. Investors who are more patient should instead become more interested if China cheapens.
If you fit that profile, you could consider two ETFs that favor Chinese stocks listed in Hong Kong or other offshore exchanges: the iShares China Large-Cap ETF, with annual expenses of 0.74%, or $74 per $10,000 invested, and Guggenheim China All-Cap ETF, with annual expenses of 0.7%.
Several U.S.-listed ETFs concentrate on the A shares listed in Shanghai and Shenzhen. They make sense only for investors who think a pogo stick is a good place to take a nap.
Source: The Wall Street Journal