Do You Have A 2019 China Plan?

November 26, 2018

[Editor’s note: Join Dave Nadig and experts from Xtrackers ETFs at DWS and BNY Mellon on ways to access the emerging market investment landscape at our free webinar on Wednesday, Dec. 12.]

 

The headline on Bloomberg on Nov. 21 was certainly an eye-catcher: “A $1 Trillion Manager Sees Emerging Market Rebound on Trade Truce Next Year”

The premise from Chris Gaffney, president of world markets at TIAA Bank in St. Louis, is pretty simple: The damage is done, the trade war will end in 2019 and emerging economies will recover fast. And it doesn’t matter if you believe him—there’s a lot of smart money calling “enough is enough” in emerging markets.

How Did We Get Here?

Sometimes, a picture tells the whole story. Here’s the performance of the major emerging market countries over the past year:

 

 

The fat line is the headline: MSCI emerging markets down 13.45%, while the U.S. market is basically flat. China and South Korea down almost 20%.

 

 

Emerging Market Rebound

That’s a remarkable amount of green on the board for a down month in the U.S. And each of these countries has its own story. Brazil had a relief rally after its recent election. India has seen a strong focus from international investors on its financial and energy sectors. But if you’re reading the headlines and planning an assault on 2019, the real focus seems to be China.

At the recent Inside ETFs Asia conference, however, my discussions with family offices and institutions in the region led me to believe the story may be even more simplistic: valuation.

Here are the current trailing price-to-earnings (P/E) ratios for the U.S., international markets and China in particular.

 

Ticker Fund P/E
IWM iShares Russell 2000 ETF 51.76
SPY SPDR S&P 500 ETF Trust 20.48
EFA iShares MSCI EAFE ETF 13.3
EEM iShares MSCI Emerging Markets ETF 11.55
CN Xtrackers MSCI All China Equity ETF  11.48
ASHS Xtrackers Harvest CSI 500 China A-Shares Small Cap ETF 11.47
ASHR Xtrackers Harvest CSI 300 China A-Shares ETF 11.21
FXI iShares China Large-Cap ETF 8.14

 

Yes, China is cheap, but it’s also historically cheap:

 

 

I’m not suggesting it’s a 1990s opportunity, but this is a market you can buy for a P/E under 12 with a projected gross domestic product more than 6% for the foreseeable future. That’s intriguing.

Which China?

But China is also a confusing market for external investors. Until recently, U.S. investors could only buy in to the companies listed in Hong Kong or directly listed in the U.S. (everyone remember the Alibaba IPO?).

Over the past few years, however, the local mainland markets in China—the so-called A-share market—has opened up substantially to U.S. investors. First, the use of a quota system, and most recently, through the creation of a North-South connect system that allows shares of Hong Kong and mainland China companies to be transacted across the border.

This liberalization of the Chinese market has led the major index providers, particularly MSCI, to begin including China A-shares in their China and emerging markets indexes. While this enhances access, it also provides a potential source of passive buyers, further upping buying pressure on the overall Chinese markets.

Here’s how the different versions of China have reacted lately to the downturn in the U.S. markets:

 

 

The broad market is up just over 5.5% in the past month, but the most interesting line is obviously the top one: the Xtrackers Harvest CSI 500 China A-Shares Small Cap ETF (ASHS).

I point it out not to suggest everyone pile in, but to highlight the opportunity set. Small-cap stocks in mainland China? Clearly not for the faint of heart, but 10% returns in a month where the U.S. sat on the fainting couch at least demands a discussion.

So, to further the discussion, join us for an upcoming webinar on what’s going on in emerging markets and China on Dec. 5 at 2 p.m. ET (you can register here). I’ll be joined by Luke Oliver from Xtrackers and Bob Humbert from BNY Mellon. We’ll dig into the challenges of accessing, analyzing and sticking to emerging market investments, the nuances of trading a market 5,000 miles away, and how to choose the right approach for you and your clients.

In the meantime, I’ll be keeping China on my watchlist.

You can reach Dave Nadig at [email protected]

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