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China Could Offer Compelling Value in 2023

Leading Chinese stocks trading in Hong Kong offer value in late 2022, but as investors have learned over the past years, the potential for rewards comes with commensurate risks.

Identifying value in the stock market is challenging these days. With the leading indices suffering double-digit percentage losses in 2022, investors have been skittish as interest rates continue to rise. The latest November producer price index came in hot at up 0.3% and above the market’s consensus expectations of a 0.2% gain as inflation continues to grip the U.S. economy. While CPI came in a touch lower than expectations, inflation is not just a U.S. issue; it is a global problem. Inflation erodes money’s purchasing power.

Since March 2022, the U.S. central bank has pushed the short-term Fed Fund Rate from zero percent to a midpoint of 4.375%, after another 50-point increase at last week’s December FOMC meeting. While the U.S.’s inflation was over 7%, Chinese inflation was below 2% in November 2022.

Chinese stocks have been under pressure over the past years for two reasons. China’s economic growth has slowed while trade and geopolitical tensions have intensified. Leading Chinese stocks trading in Hong Kong offer value in late 2022, but as investors have learned over the past years, the potential for rewards comes with commensurate risks.

Chinese large-cap stocks have underperformed the S&P 500 in 2022, and since 2007. FXI (FXI - $32.00 1.23 (3.701%)  ) is a Chinese large-cap ETF product; it reached a record $73.19 high in October 2007. Since then, FXI is 61.8% lower, and the SPY (SPY - $400.72 4.96 (1.223%)  ) is 147.9% higher over the same period. Now, in 2022, FXI is 23.6% lower, and the SPY fell 19.3%. Chinese stocks continue to lag the leading U.S. stock market index.

At the same time, economic issues have weighed on Chinese shares. The U.S. emerged from COVID-19 lockdowns and mandates in 2022. China suffered from government mandates and COVID-19 protocols throughout 2022. U.S. trade policy has weighed on Chinese exports and increased tariffs over the past years. Further challenges to the Chinese economy come from weak domestic demand, rising unemployment, a housing crisis, increasing government debt, currency depreciation, and the risk of growing restrictions on China’s access to global technology, capital and markets.

And geopolitics have made investors skittish. In February 2022, at the Beijing Winter Olympics opening ceremony, Chinese President Xi and Russian President Putin shook hands on a “no limits” alliance. Less than one month later, Russia invaded Ukraine. Russian aggression in Ukraine caused investors to worry that China would force reunification upon Taiwan. The geopolitical bifurcation between the world’s nuclear powers with the U.S. and China on opposite sides has caused investors to avoid Chinese assets.

Four Reasons Chinese Shares Offer Value

  • Reason No. 1: Potential. China is the world’s second-leading most populous economy.
  • Reason No. 2: Value. The price-to-earnings ratio on FXI is 9.27 times earnings. The P/E ratio on SPY is 16.41 times earnings.
  • Reason No. 3: Recent domestic developments. China has eased COVID-19 protocols in response to demonstrations.
  • Reason No. 4: Geopolitics. China’s President Xi and U.S. President Biden recently reiterated that a nuclear war “should never be fought.”

The Buffett-Munger approach says Chinese stocks are a bargain. Warren Buffett once said, “Price is what you pay, value is what you get,” and “Be fearful when others are greedy, and greedy when others are fearful.” In September 2022, Charlie Munger, Warren Buffett’s partner, said, “China is opening up more to foreign investors, and its markets are getting stronger and stronger.” Charlie Munger’s latest Q3 13F filing showed that his Daily Journal Corp. holds 300,000 shares of Alibaba (BABA - $111.20 7.18 (6.065%)  ), the Chinese e-commerce giant and Munger’s third-largest holding. FXI has an 8.66% exposure to BABA. Identifying value is challenging, and Chinese stocks offer value at current price levels.

The potential for rewards comes with commensurate risks. The higher the risk, the more significant the potential rewards. Chinese stocks could be overdue for a significant upside correction in 2023.