China ETFs: Don’t Dismiss the Slipping Tiger

ETF Trends

What a difference a year makes. A year ago, Chinese inflation was still above 6% and investors were worried about a property bubble. These days Chinese stocks, as measured by the Shanghai Composite Index, are trading at their lowest level in more than three years.

Worries abound that the world’s second-biggest economy is stuck in the doldrums, and data released on Monday showed China’s imports and exports underperformed expectations for August. But this low may be a good opportunity to buy Chinese equities for long-term investment portfolios.

Stocks are trading close to trough valuations, with the price-to-earnings (P/E) ratio at less than nine times forward earnings and price-to-book (P/B) at around 1.25. Our in-house model is forecasting growth of approximately 7.8% to 7.9% in the third quarter, slightly ahead of the consensus.

While China’s long-term growth rate is lower than it was five years ago, the country can avoid the hard landing that many fear. To be clear, China is in the midst of a cyclical slowdown that has lasted longer and been more pronounced than expected. The Chinese Purchasing Managers Index (PMI) has been stuck at around 50 for the past three months, and the new orders component has fallen to 49, an eight-month low. Domestic consumption has also dropped off, with retail sales at 13.1%, the slowest level since February of 2011.

But other factors support China hitting its growth target of 7.5% to 8% annually, especially the strength of consumers’ personal finances. The Chinese carry a remarkably low debt burden and their income is growing at a healthy pace. Income growth has remained stable, and in some instances even accelerated: up 12.5% year-over-year for urban dwellers, slightly ahead of the long-term average. In addition, loan growth has stabilized at around 16%, which has in turn led to a pickup in the money supply.

While we are skeptical that China will return to double-digit growth anytime soon, if ever, current indicators are not signaling a hard landing. While there are significant risks to the Chinese market – an opaque banking system and a real-estate crash being two – I feel that the slowdown in growth is already reflected in the price of Chinese equities. Should the economy decelerate further, I would revisit my view. But for now, I think the bad news is already baked into the price.

iShares FTSE China 25 Index ETF (FXI)

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Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist.

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