Chinese equity provides good opportunities for investors, Neuberger Berman’s Yao says
Frank Yao, senior portfolio manager in Neuberger Berman’s Greater China Investment team, discusses why Chinese equity markets are providing compelling opportunities for investors.
• China is facing liquidity issues due to a combination of capital outflows from China, seasonal quarter-end liquidity tightness, and the Central Bank in China’s failure to act to alleviate liquidity issues
• Valuations for the domestic and overseas-listed Chinese equities are at their lowest point in recent years
• New political leadership has made a concerted effort to move toward long-term market reform: as market confidence builds, we expect the asymmetry between equity market performance and GDP and earnings growth to correct
Revisiting China Equities
China equity markets have retreated materially since May, in part due to a potential exit by the US from quantitative easing, but mainly because of recent liquidity tightness in mainland China.
We believe these liquidity issues are resulting from a combination of capital outflows from China, seasonal quarter-end liquidity tightness, and the Central Bank in China’s failure to act to alleviate liquidity issues. We think the current liquidity situation is extreme, technical and short term, and that it will be resolved soon with a liquidly injection from the central bank.
With this in mind, we believe that current Chinese equity markets provide what we consider a compelling opportunity for value-oriented investors. Valuations for the domestic- and overseas-listed Chinese equities are at their lowest point in recent years (as of June 21, 2013) – lower than late 2008 levels and roughly half the historical averages.
As of June 21, 2013, the MSCI China Index, a proxy for overseas-listed China equities, is trading at 7.9 times forward earnings (versus the historical average of 16) and 1.2 times book value. The CSI 300 Index, representing domestically listed China equities, is trading at 9.1 times earnings, versus the historical average of 19. Coupled with double-digit 12-month EPS growth expectations for the MSCI China and CSI 300, we believe valuations are currently very attractive.
China Equity Valuations Are at Their Lowest Point Since 2006
From January 2008 through March 2013 (the latest available reporting date), the China domestic A-shares market, represented by the Shanghai Composite, is down about 57%. During the same period, China’s real GDP growth has increased more than 66% and earnings growth of China A-share companies has increased about 92%.
The new political leadership has made a concerted effort to move toward long-term market reform rather than rely on stimulus packages to foster growth. As the market builds confidence in the new leadership’s reformist-based approach and recognizes that the rate of inventory destocking has started to stabilize, we expect the asymmetry between equity market performance and GDP and earnings growth to correct.
Focus on Fundamentals
We favour what we consider to be quality individual names that demonstrate strong visibility of top and bottom line growth and recurring cash flows from core businesses. By focusing on such bottom-up fundamentals, we believe investors can seek to capitalize on the opportunities of the Chinese market while mitigating some of the risk.