The crises in Russia, Iraq and the Middle East may have derailed the S&P 500 this summer, but they’ve been great for China stocks.
Throw in low prices and a bad-news-is-good-news backdrop, and China stocks look like outperformers through the end of the year at least.
True, anyone holding China stocks through exchange-traded funds such as the S&P China SPDR (GXC), the iShares China Large-Cap (FXI) or the Guggenheim China Small Cap (HAO) was probably on the verge of losing patience. After all, China stocks have been underperformers for five years running and have staged two abortive rallies this year alone.
But China stocks such as Tencent (TCEHY), China Construction Bank (CICHY) and China Mobile (CHL) are having a sizzling summer — the GXC, FXI and HAO ETFs are up anywhere from 14% to 16% over the last three months vs. a mere 2% gain for the S&P 500.
And the latest rally looks sustainable.
Partly that’s because some of the biggest weights on U.S. and European stocks aren’t going away anytime soon. The West’s conflict with Russia over Ukraine and the wars in Iraq and Gaza look intractable at this point, with Russia in particular causing serious damage to the economies and stock markets of Europe.
China stocks, however, are largely insulated from the geopolitical crises knocking global markets right now. The Shanghai market is mostly closed to foreign investors, so China stocks move more on domestic news and data. Russia, Ukraine, Iraq, Syria, Gaza and Argentina are largely immaterial to China’s homegrown investor class.
China Stocks on Sale
There are other forces driving and supporting China stock at this point, too. Namely, in addition to being a relative safe haven against destabilizing geopolitical forces, they also benefit from being relatively cheap.
The multiyear rally for global equities has made valuations stretched, especially in the U.S. That’s not to say the S&P 500 is overpriced, but even the most bullish market players admit that it’s hard to find bargains in U.S. equities.
Scan the globe and China stocks — banks in particular — are one of the few places in equities where valuations still are below their long-term averages, notes Russ Koesterich, BlackRock’s chief investment strategist.
China stocks also are benefiting from that perverted market dynamic known as “bad news is good news.” That’s where weak data increases the likelihood of more government stimulus. Indeed, China stocks rose Wednesday on speculation the government will further support the economy with rate hikes after disappointing readings on credit growth and industrial production.
By no means have investors suddenly adopted a rosy view of China, though. It’s just less bad. Here’s the chief of the Hong Kong Monetary Authority in The Wall Street Journal:
“Fund managers have switched their view towards China’s fundamentals — they still haven’t completely turned bullish, but are obviously less bearish — which has probably increased their asset allocation towards Hong Kong stocks or A-shares.”
The economic recovery remains fragile enough to warrant more government support but not so weak as to spook investors. Geopolitics make China stocks a relative safe haven, and they’re one of the last places in the world where you can find compelling valuations.
Taken together, that’s a heck of a bull case for China ETFs like FXI, HAO and GXC to keep putting up market-beating gains.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.