Investors have been waiting for a selloff in U.S. stocks for years -- anything to bring prices back into some semblance of value-territory. The 10% correction in January was an opportunity, albeit a short-lived one, with the S&P 500 regaining nearly 8% in less than three weeks.
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While most analysts aren't calling for a U.S. recession until late next year or 2020, a bear market has quietly presented an opportunity somewhere else…in one of the world's fastest-growing economies.
Shares trading on the Shanghai Stock Exchange have plunged 20% since the late-January peak on slowing economic growth and the escalating trade war with the United States.
It may be the opportunity and wake-up call U.S. investors need. Snapping up shares of companies primed to benefit as China takes its place as an economic powerhouse and build a portfolio from almost no exposure to the space.
The Selloff Opportunity On The Other Side Of The World
While the U.S. market has held up against the escalation in the trade war, the Chinese markets have sold off sharply. The first salvo was fired this month as the U.S. and China both levied tariffs on $34 billion in goods and threatened another round on $16 billion. President Trump signaled last week that new tariffs would be coming soon after the administration detailed a list of $200 billion in Chinese imports targeted for a 10% tariff.
Despite the near-term worries surrounding China, the country is on track to become an economic equal to the U.S. this century. The IMF forecasts the Chinese economy to grow 6.6% this year, adding over $800 billion to the $12.37 trillion economy.
To put that into perspective, the U.S. is forecast to add just $484 billion to its $19.39 trillion economy this year.
Despite that march to economic hegemony, Americans hold just 15.6% of their total equity portfolio in international stocks and just 5.8% in emerging markets including China. This underexposure to companies domiciled in faster-growing countries could become a problem if returns on U.S. stocks slow.
Analysts at Morningstar expect U.S. stocks to return just 1.8% annually over the next 10 years. Vanguard founder Jack Bogle is slightly more optimistic…but still expects just 4% annualized returns before inflation over the next decade.
Early indications are that the trade war will get worse before it gets better. Neither side looks willing to back down, and solid economic growth in both countries gives policymakers room before popular support wanes.
There is one reason to believe trade-related losses to Chinese firms may not be as painful as some believe. One advantage of Chinese companies that investors have largely overlooked in the trade war is the government's explicit role in the economy.
While U.S. officials can talk up domestic firms and try to promote policies that favor U.S. business, a capitalistic system is, by definition, hands-off. In the communist model, the Chinese government can directly aid companies to protect industries from any trade-related pain. Officials have already allowed the Yuan to slide nearly 7% since January, making exports cheaper and offsetting some of the increased costs from tariffs.
3 Long-Term China Stocks In Value Territory
Investors eager to diversify into the space can get broad exposure through the SPDR S&P China ETF (NYSE: GXC), a fund of 364 companies with an average price multiple of just 11.9 times trailing earnings. The fund is more diversified than the more popular iShares China ETF with no sector accounting for more than 37% of holdings. Shares are down 15.5% since the January high and pay a 2.2% dividend yield.
Investors looking for individual stocks can find some strong picks in best-of-breed names beaten by investor sentiment but with little or no exposure to trade tariffs.
China Life Insurance (NYSE: LFC) manages the broadest distribution network among insurers in China with 31 provincial-level branches, covering over 420 million policyholders. Gross written premiums jumped 19% last year with a 29% increase in renewal policy premiums.
The country's insurance market may be one of the few totally immune from the trade war and a rising middle class means people have more to protect. The World Economic Forum forecasts the Asian middle class to reach 1.75 billion by 2020 from just 500 million a decade earlier. That's more than the entire population of the Western Hemisphere.
Shares of China Life trade for 1.45-times book value and pay a 2.5% dividend yield. That's less than half the average multiple of 3.0-times book value for U.S.-based insurers.
China Mobile Limited (NYSE: CHL) is the world's largest wireless operator with 894 million customers and 62% of the Chinese wireless market. As the government is the company's largest shareholder, it's expected to receive significant protection against foreign and even some domestic competitors.
The company's lead in the world's largest telecom market has made it a cash machine. China Mobile generated $7.7 billion in free cash flow last year even after $29.1 billion in capital spending. The company has nearly $70 billion in balance sheet cash with no long-term debt.
Shares of China Mobile trade for 1.24-times book value and pay a 4.5% dividend yield. That's less than half the average multiple of 3.1-times book value for U.S.-based telecom carriers.
NetEase Inc (NYSE: NTES) is the largest online services provider in China with revenue from its e-commerce platform and online gaming. Sales on its e-commerce platform surged 157% last year to support slower growth in gaming which accounts for about 75% of total revenue. The company is also starting to monetize its gaming segment with movies and mini-series based on the characters in the games.
U.S. gamer penetration has hit 66% with $36 billion spent annually online and through mobile games. In China, that penetration is just 42% but that still means 583 million people regularly participate. Shares of NetEase have fallen 29% from the January peak and trade for 30-times trailing earnings, roughly even with U.S. internet peers but with a stronger growth outlook.
Risks To Consider: All signs point to an escalating trade war and more pain for shares of Chinese companies. Investors may want to gradually build a position over a year rather than invest all at once.
Action To Take: Use the trade-related selloff to pick up long-term China plays at a discount before strong economic growth and a huge market take them higher again.
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