China stocks fell for a fifth day running on Wednesday leaving the main Shanghai index of China’s largest companies, the CSI 300, down by around 20% over the period. Between its peak in June and Tuesday’s close the Shanghai index is down by around 43%.
Neuberger Berman’s China Equity Fund manager Frank Yao said the falls have compressed the forward price/earnings ratio for companies in the CSI 300 index, which represents the A share market, to around 11.3 times. The offshore market, represented by the MSCI China index, now trades at around 9.1 times.
While the debate still rages over whether the latest price falls are linked to the outlook for the real economy and whether Chinese authorities can successfully manage the rebalancing currently underway from investment-led to consumption-led activity, it is clear that many companies are now at more attractive valuations.
“The sheer size of the Shanghai market, with more than 1100 companies, along with the Shenzhen bourse and its 1,700 names, gives plenty of scope for stock picking,” argues Gary Greenberg, head of Hermes Emerging Markets and lead portfolio manager.
"Investors should be wary of, not deterred by, the volatility.”
“Such stock-picking opportunities, and the likelihood that Chinese economic reform will continue throughout this turbulence, means that investors should be wary of, not deterred by, the volatility,” Greenberg said.
Concern overdone
William Fong, investment director, Asia Pacific equites, at Baring Asset Management is another supporter of the view that there is opportunity out there despite the market turbulence.
Fong argues that the concern over the pace of growth in China, the devaluation of the yuan and the impact on investment flows of from a new US interest rate cycle, which have all been cited as reasons for this week’s market turbulence, are overdone.
“It is our belief that the decline (in share prices) is not justified by fundamentals and that the focus on particular economic data points misses the extent of change in China’s economy in recent years.
“The recent volatility has created stock picking opportunities for us, increased the potential for strong companies to act as consolidators and emerge stronger, and depressed valuation levels for investors,” he said.
However, Heinz Ruettimann, emerging markets strategy research analyst at Julius Baer, argued that cheap valuations are not enough for investors to return just yet.
“If you look at the CSI 300 index, during the financial crisis it traded at a p/e of 11.7 and now it trades at a p/e of 12.6, so the index could drop further. But yes, there is a downside cushion from a valuation perspective looking at the MSCI China and the China Enterprise index (HSCEI). True.
“But cheap valautions are not enough because investors are not so certain anymore of the extent of which the Chinese authorities can manage the economy.”
“Valuations alone do not make a clear investment case for me. I’m waiting for a fully functioning market again with no interventions from the regulator,” Ruettimann said.
Stock picks
For those investors willing to risk a return to the market Baring’s Fong said he is focused on modern, forward thinking companies with high quality management and strong balance sheets with a clear franchise it is able to exploit, and the ability to deliver robust long-term profits growth.
Greenberg at Hermes said that fundamentally profitable companies with good balance sheets and competent management teams, at reasonable prices, should prove to be good long-term investments, even if the Chinese economy slows.
“Some of our companies are manufacturers that sell products overseas, providing some insulation from domestic events,” he said.
Ruettimann said the big banks in China do look attractive because not only are their valuations extremely low, their earnings look better insulated from any future cuts in interest rates. He said banks would also gain from any efforts by the Chinese government to support the economy.
