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        Is It the Time to Consider Chinese Stocks?

        Views 58642023.05.16

        What are the investment opportunities and risks in China concept stocks

        March 2022 was undoubtedly an eventful month for China concept stocks. From the darkest moment in the first half of the month, the stocks continued to plunge until a violent recovery later. At the moment, the market trend of China concept stocks remains unclear. In this article, let's look into the future of China concept stocks.

        In a narrow sense, China concept stocks generally refer to a set of stocks of Chinese companies listed in the United States. However, in a broad sense, any stock of listed Chinese companies in the United States, Hong Kong SAR, or China mainland can be called a China concept stock.

        Aside from short-term fluctuations, the investment prospect for China concept stocks may lie in the following three aspects in the long run.

        Firstly, the growing Chinese economy brings potential market opportunities and nurtures many high-quality companies.

        Investing in stocks is investing in a portion of a company. Where a company is based can be critical, as the company may ride on a wave of the country's development. Warren Buffett's success was inseparable from US economic boom during most of his investing career.

        The rapid growth of China's economy over the last few decades has given rise to the emergence of many high-quality companies. Even amid COVID-19 outbreaks, China leveraged its enormous domestic market and maintained its manufacturing edge to steady the ship. It remained one of the most robust economies globally.

        Benchmarking the development path of the US stock market, China has the potential to give birth to a large number of excellent companies in fields such as consumer goods, medical care, emerging technologies, and innovations, whose stocks might have bright futures, albeit with risks, further explained below.

        Secondly, more cash flows have brought greater liquidity to China concept stocks.

        In terms of domestic capital, against the backdrop of wealth reallocation, China concept stocks may see more capital injection and increased liquidity.

        In the past, with the perception that property prices would keep rising, a large proportion of Chinese people's assets were heavily tied to real estate. Many people bought houses when they had extra money. Most of the capital flew into the property market instead of the stock market. With proper regulatory policies, speculative property investments have been curbed to a certain extent in recent years. The lure of the property market has weakened, so some of the money starts entering the stock market.

        In addition, the idle funds of the Chinese people have gradually moved from savings to the securities market in recent years. Such a shift might bring more capital to China concept stocks.

        In terms of foreign capital, although the amount of foreign investments in China concept stocks may continue to fluctuate in the short term due to policies and market conditions, an upward trend is likely in the longer term, partly driven by China's economic development.

        Foreign investors can freely invest in China concept stocks listed in Hong Kong or the US and trade A-shares via Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect. For example, as of February 2022, over 3 trillion RMB worth of A-shares have been bought by foreign investors, which is about two times higher than that in 2018, but only accounts for about 3.6% of the total market value of A-shares. This proportion is far lower than that of foreign shareholding in most emerging markets.

        (Source: Wind Information; chart plotted by Huaxi Securities)

        As China's capital market continues to open up, foreign investors may continue to increase their investments in Chinese assets and bring more liquidity to China concept stocks.

        The liquidity of funds largely influences the development of a stock market. China concept stocks may find more opportunities with more domestic and foreign capital injections.

        Thirdly, the valuation of China concept stocks is relatively low after the plunge.

        From February 2021 to March 2022, due to some regulatory differences between China and the US, as well as policy risks in certain industries, China concept stocks experienced a historical decline that lasted for 13 months. China concept stocks in US exchanges lost up to 75% of value. Hong Kong's Hang Seng Index fell by 45%, the Hang Seng TECH Index fell by nearly 70%, and the SSE Composite Index dropped by almost 20%, marking a rare phenomenon in history in terms of both the duration of the downtrend and the magnitude of the drop.

        With this round of decline, the overall value of China concept stocks has hit historic lows.

        In terms of data, as many technology companies that are not yet profitable were listed in the United States and Hong Kong stock markets over the last two years, the price-earnings ratio offers little insight. Therefore, the price-to-book (PB) ratio could help us better gauge market trends.

        The table data is based on the closing price on June 15, 2022; Sources: danjuanapp app

        After experiencing this round of long-term plunge, the PB ratio of China concept stocks has almost fallen to its historical low. For example, the CSI 500 index, an A-share benchmark reflecting the stock performance of small-mid cap companies, is now cheaper than 93.0% of the time in history. Hong Kong's Hang Seng TECH Index is now cheaper than 86.4% of the time in history, and the China Internet Index is now cheaper than 97.2% of the time in history.

        In contrast, the PB ratio of leading US indices, S&P 500 and Nasdaq 100, is now more expensive than about 80% of the time in their history.

        After a long-term uptrend until 2021, the valuation of the US stock market is relatively high, rising to the point where investors may start taking measures to mitigate risks. In contrast, after a historical decline, the valuation of China concept stocks is relatively low, bringing in more potential opportunities.

        It must be noted that any investment carries risks, and the potential high returns of stock investment are also accompanied by high risks.

        Even after the long-term plummet, the regulatory issues that have plagued Chinese concept stocks remain unclear, industry policy risks have not been eliminated, and the market sentiment is still bearish. Hence, there are still significant uncertainties about the short-term trend and we should not overlook the risks.

        However, from a long-term perspective, investing in stocks is investing in companies whose development depends largely on the country's economic environment. A growing economy like China nourishes outstanding companies, including some China concept stocks. Meanwhile, more capital inflows will bring more liquidity to China concept stocks. With the endogenous growth and capital promotion of China concept stocks, the low valuation of some outstanding companies may also return to normal, bringing long-term investment returns for investors.

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