Beware the Hidden Risk Lurking in China
If you were able to go back in time one year, would you invest in Chinese or European stocks?
Given the mess that’s been going on in Europe, most investors would likely go with China without thinking twice.
But even with all of its troubles, Europe has outperformed the Shanghai Composite Index significantly in the past year.
Take a look…
It’s not just Europe that’s spanking China, either. Ever since the end of the crisis, Chinese stocks have lagged all major markets.
Right now, the Shanghai Index trades just 20% above its lowest point from the collapse five years ago – when the S&P 500 sold for just 10 times historical earnings.
Of course, I’ve been warning against Chinese stocks the whole way down. Single stocks carried too great a risk of fraud. And the market as a whole was bound for a slowdown.
That slowdown has, indeed, materialized. The country hasn’t been able to keep GDP growth up to levels seen a few years ago.
However, now that China’s market is trading at just 11 times earnings, some investors are likely wondering if this much downward momentum is justified…
After all, it’s still a growing country. And when you monitor earnings reports in the United States, executives across the board have cited the slowdown in Europe as a drag on profits. Rarely does Asia get blamed.
Plus, despite its slowing growth, China’s GDP still outpaces the United States by nearly four times over.
The struggling stock market just doesn’t match up with the economic fundamentals. Especially considering that the rest of Asia doesn’t seem to be experiencing the same downward pressure.
As you can see in the chart below, Japan is outperforming China’s market – as measured by the Shanghai Composite Index. Even the Hong Kong Exchange, which is comprised principally of stocks for Chinese companies, isn’t as affected.
So what’s going on here? Is China actually undervalued – making this the perfect buying opportunity?
Don’t bet on it.
We know there are a lot of risk factors in China right now. The real estate market is set for a collapse. The growth, so far, has largely been propped up by government spending. Political tensions are on the rise…
While these risks may never blow up, the threat they pose isn’t going away, either. And that perception alone will keep Chinese stocks from commanding a higher valuation.
Besides, who knows what other hidden risks are lurking behind the scenes, keeping prices down? There’s too much we can’t know about a semi-planned economy with zero transparency.
Bottom line: Despite the seemingly exaggerated stock market decline, I’m convinced that Chinese stocks will remain stagnant for years. That is, if the country doesn’t see an all-out collapse.
Ahead of the tape,
Matthew Weinschenk
Related Topics: Economy and Politics, Emerging Markets, International, Market Analysis, Think Contrarian
