China Stock Market: Decline Presents Opportunity

The Tiananmen Square massacre, in which Chinese troops killed hundreds of pro-democracy protesters, occurred 25 years ago last week. While the Chinese government didn’t give their people democracy, it did give them capitalism.

Just 18 months after the massacre, in December 1990, the government opened the Shanghai Stock Exchange.

Since then, China has become one of the world’s fastest-growing economies. According to the World Bank, the per capita growth of China’s gross domestic product since Tiananmen Square is 8.8% on an annualized basis.

“While the Chinese government reacted harshly to the protesters in Tiananmen, it’s made a concerted effort to increase growth and wealth over the past 25 years, which has had a huge impact on the population,” said Jonathan Brodsky, managing director of Advisory Research, a Chicago asset management firm with $11 billion under management.

“The pro-growth initiatives, which have been a powerful tool of the government to maintain stability, were accelerated in the face of Tiananmen.”

Brodsky runs Advisory Research Emerging Markets Opportunities Fund , which has more than 20% of its assets invested in China. The fund was up 9.5% this year going into Monday.

On the 25th anniversary, June 4, 2014, the Shanghai Composite Index closed at 2024, a 1,924% rise from when the market opened. However, even though China posted phenomenal growth over that period, the stock market has experienced enormous volatility on a fairly regular basis. The index is down 66% from its peak of 6092 on Oct. 16, 2007.


Sentiment Sours

Investor sentiment has soured on China for a variety of reasons. Top of the list is that China’s economy has slid from the phenomenal growth rate of 10% a year to the merely great annual rate of 7%. Part of this is related to the declines in the economies of its trading partners in the developed world.

Domestically, the country is suffering from a bubble in the real estate market, a slowdown in consumer spending and high debt levels in the Chinese banking industry. Add to that China’s shadow banking industry, which sells Chinese consumers lightly regulated, obscure investment products, and you can see significant risk to the economy.

Problems Already Discounted?

“The problems are not new and they are fully discounted, maybe more than fully discounted, creating one of the best opportunities to buy China in a decade,” said Jim Oberweis, president of Oberweis Asset Management in Chicago. The firm manages $5 billion in assets, including the Oberweis China Opportunities Fund . The fund gained 60% last year but is down 4.9% year-to-date.

Among ETFs, iShares China Large-Cap ETF (FXI), which holds 25 of the biggest Chinese stocks, currently trades at a price-earnings ratio of 7.6 and a price-to-book value of 1.1, while the S&P 500 has a P/E of 17, according to Morningstar. The fund is down 3% year-to-date, after rallying 5.3% over the past three months.

Global X China Financials ETF (CHIX), which has a P/E ratio of 6, is down 5.9% year-to-date, following a 6.6% rally over the past three months.

IShares MSCI China ETF (MCHI), with a P/E of 9, is down 3.8% year-to-date, after rising 2.3% the last three months.

Originally published in Investor’s Business Daily.

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