China’s Bargain-Priced Stock Market Plays Catch-Up

It is fashionable to bash China these days. Granted, its stock market has drastically underperformed in recent years: Since 2012 began, the Shanghai Composite Index is down 6.6 percent, compared with a 57.2 percent rise in the S&P 500 Index over the same period.

That’s why it’s not surprising to find that plenty of folks still take a cautious view about investing in China. Fears of an over-inflated housing bubble and imminent credit crunch abound.

You just can’t find many bulls on Chinese stocks today … and that’s precisely why this market deserves a closer look.

From a true contrarian investor’s perspective, it doesn’t get much better than this, because fears of an economic meltdown in China appear overblown. Peel back the top layer of the inefficient, old state-owned enterprises, and you’ll find a vibrantly growing domestic economy driven by a unique brand of oriental capitalism.

China’s consumer-oriented service sector has grown at a faster clip than the industrial sector for seven straight quarters.

New political leadership in Beijing at the start of 2013 stressed social reform and rebalancing China’s economy away from industrial-led export growth, in favor of more organic domestic consumption growth. And this crucial policy change is already yielding very favorable results.

Just released second-quarter data shows growth in China accelerating again, with gross domestic product growth of 7.5 percent, after a brief slowdown last year. China’s consumer-oriented service sector has grown at a faster clip than the industrial sector for seven straight quarters; expanding 8 percent year over year last quarter, versus 7.4 percent industrial growth.

Greater reliance on consumer goods and services means faster employment growth and higher wages, which in turn promotes rising consumer wealth and spending. Judging from the bullish numbers below, I’d say China’s economic transition is well underway …

* Wage growth has exceeded growth in the broader Chinese economy for the past five quarters. In the first half of this year alone, urban incomes jumped 9.4 percent, compares to 8.5 percent GDP growth.

* China now accounts for 16 percent of worldwide GDP, a share which has doubled in just the past 15 years. And consumption now accounts for more than half of total Chinese economic growth …

* China’s fast-growing consumer class now spends more as a percentage of global GDP than Japan’s, and they’ve pulled dead-even with consumers in all of Europe …

* And these are savvy consumers too. China already has almost three-times more people online as in the U.S. and internet usage is growing 10 percent annually, versus only 2 percent in the U.S. Plus there are nearly four times more mobile phone users in China as in the U.S. already!

In fact, from 2011 to 2013, China contributed more to global consumption growth than any other nation on earth, including the USA.

Still, the critics contend that much of China’s recent growth has been squandered in misguided capital spending. But nothing could be further from the truth.

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In fact, the chart above shows that in historical terms, China’s expansion is following roughly the same trend as in the U.S. — but China is only on par with U.S. levels when Neil Armstrong first set foot on the moon 45 years ago. That means there are still plenty more railroads, airports, pipelines, factories, businesses and shopping malls to be built!

China has plenty of room for capital investment and growth for decades to come. And Beijing is directing capital spending toward more productive industries including: technology, clean energy and consumer services.

In spite of this remarkable transition from an export-led economy to internal consumption growth, investors remain skeptical about China’s investment prospects. And I can understand why: its stock market has lagged far behind, but that’s beginning to change.

It appears the tide may finally be turning in favor of Chinese stocks, which also happens to be one of the world’s most undervalued markets right now.

Over the past three months, the Hang Seng China Enterprises Index of Hong Kong listed Chinese mainland companies has gained 7.1 percent. By contrast, the Dow Jones Industrials gained just 3.8 percent since then; Chinese stocks are quietly playing catch-up! Plus, on a relative valuation basis stocks in China are an absolute bargain compared to the U.S. and most other global markets.

The China Enterprises Index has a trailing P/E ratio of just 7.8 times earnings right now, and a dividend yield of 4.1 percent.

U.S. stocks by contrast are trading at 18.4 times trailing profits and 16.6 times this year’s hoped-for earnings and yield just 1.9 percent.

Bottom line: Investors aren’t paying as much attention to China’s stock market after several years of underperformance. As a result, Chinese shares are incredibly inexpensive right now; on sale at less than half the valuation of U.S. stocks and offering twice the dividend yield. For my money, select stocks in China are worth a much closer look.

Good investing,

Mike Burnick

P.S. Remember to watch your inbox for Mike Larson’s afternoon Money and Markets column. That’s where you’ll find today’s closing numbers, a timely feature story, and readers’ comments.

Mike Burnick, with 30 years of professional investment experience, is the Executive Director for The Edelson Institute, where he is the editor of Real Wealth Report, Gold Mining Millionaire, and E-Wave Trader. Mike has been a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. He also served as Director of Research for Weiss Capital Management, where he assisted with trading and asset-allocation responsibilities for a $5 million ETF portfolio.