China with a GDP of 19.4 Trillion is now the #2 economy in the world vs. the US with an economy of 26.9 trillion both expressed in US Dollars. However in purchasing power parity levels the Chinese economy is actually bigger than that of the US.
Source: IMF
If we look at the historical performance of Chinese stocks compared to US stocks over the past 20 years, highlighting that despite China's rise as a global economic powerhouse, the US S&P 500 has outperformed Chinese stocks. In the chart below the S&P 500 (green line) is compared with the China Shanghai Index (CSI 300 Index) (blue line). The CSI 300 measures the price performance 300 largest stocks listed on Shanghai and Shenzhen stock exchanges. Like the S&P 500 it is also market-cap weighted bu unlike the S&P 500 which is US dollars, the CSI 300 is in Chinese Renminbi (CNY).
As can be seen from the above chart the CSI 300 index is much more volatile than the S&P 500. The CSI 300 after it was first formed, shot out of the gates and formed a massive bubble between 2006 and 2009 followed by a series of bubbles and bursts. Currently it in one of the trough phases as the Chinese economy struggles through an economic downturn. The S&P 500 in contrast has relatively steadily chugged along after the Great Financial Crisis in 2007 to 2009 and has overall outpaced the CSI 300 over the last 18 years.
U.S. stocks are currently about twice as expensive (S&P 500 PE of 23.40) as Chinese stocks (CSI 300 PE of 12.6) based on 12-month trailing price/earnings multiples. ( Forward PE Ratio's for the two indexes are 20.01 and 11.09 respectively.)
Last few years have been bad for Chinese stocks overall but some contrarian investors are optimistic about Chinese stocks, citing factors such as targeted fiscal stimulus and a solidly growing Chinese economy. As China's economic growth converges with U.S. levels in the coming years, the gap between Chinese and U.S. economic growth may narrow. Factors such as slowing growth, demographics, deleveraging, and trade tensions are seen as potential long-term drags on Chinese growth.
Symbol | YTD | 1 Year | 3 Years | 5 Years | 10 Years |
|---|---|---|---|---|---|
| SHSE:000300 | -7.36 | -2.69 | -10.21 | 2.51 | 4.50 |
| ^GSPC (S&P 500) | 15.00 | 11.60 | 7.59 | 9.67 | 9.56 |
Valuation
Buffett Indicator
According to the Gurufocus page of the Buffett indicator (the ratio of total market cap (TMC) to Gross National Product (GNP)) for the US market the market is now significantly overvalued. Gurufocus estimates that the US market is currently overvalued by between 123.6% (using the modified criteria) and 156% (using the original Buffett criteria).
In contrast the Gurufocus labelsthe Chinese stock market as "Modestly Undervalued". The Buffett indicator is only at 57.58% and 43.15%. So in terms of the Buffet indicator, the Chinese equity market is valued at 1/3rd of the level of the US equity market.
Using the Buffett criteria, Gurufocus projects that China will return 9.1% per annum over the next few years vs. 2.3% for the US. Of course these projections are theoretical and as Yogi Berra said while "In theory there is no difference between theory and practice - in practice there is".
Shiller PE
The Shiller PE which takes 10 years median PE Ratio is another popular valuation criteria. The US Shiller PE is currently at ~31 while the Chinese Shiller PE is at ~14. This also confirms the conclusion from the Buffett indicator that the Chinese stock market is relatively better value.
How to Invest in China?
I think the best method for a foreign investor, investing in the Chinese domestic market is to invest via a broad market ETF. Some suggestions are as follows. The following ETF's are in US dollars (USD).
- iShares MSCI China A ETF (CNYA). CNYA tracks the MSCI China A Inclusion Index. The ETF has an expense ratio of 0.6%.
- KraneShares Bosera MSCI China A 50 Connect Index ETF (KBA). This is similar to the above but targets the top 50 domestic stock in China. Expense ratio is 0.56%.
- Xtrackers Harvest CSI 300 China A-Shares ETF (ASHR). ASHR tracks the CSI 300 index. Expense Ratio is 0.65%.
For Canadian investors iShares China Index ETF (TSX:XCH) is a viable alternative priced in Canadian dollars with an expense ratio of 0.85% It gives exposure to equities of 50 of the largest Chinese companies, by market cap, in a single fund
The cheapest from a expense ratio view point is actually the iShares Core CSI 300 ETF(HKSE:2846) however this ETF trades on the Hong Kong Stock Exchange in Hong Kong dollars (HKD). The expense ratio is only 0.16%.
The top holdings of the above ETF's include Class A shares of Kweichow Moutai a manufacturer of alcoholic beverages, Contemporary Amperex Technology the largest EV battery maker in the world, and Ping An Insurance (Group) Company of China, Ltd., a conglomerate offering insurance, banking, asset management, financial, and other services.
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Conclusion
I think currently the Chinese stock market is valued much cheaply than the US. Over the long-term value's do revert to the mean. When that will happen is anybody's guess - as one wag commented, "in the long term, we are all dead.". While the days of double-digit growth of the Chinese economy are likely over, it will eventually get over its current weakness and settle into a 2 to 3% growth trajectory similar to more developed western markets.
However, unlike the US, Chinese financial markets are not as well developed as the US or even other western countries such as UK, Canada or Japan. Chinese stocks are subject to wild swings, so volatility is to be expected and par for the course. However, unlike the US inflation is China is under control and long-term central bank interest rates are low.
China is also stimulating the economy vs. the US which has currently a restrictive interest rate policy. China's discount rate is 2.9% vs. 5.33% in the US. China is already in a recession while the US in not, but may be facing one next year. All in all, this seems to me to be a reasonably good time for long term investors to overweight China and jump on the recovery bandwagon.
