China stocks have been getting quite a lift in 2015. Two of the largest China ETFs by assets, the iShares China Large-Cap ETF (FXI) and the SPDR S&P China ETF (GXC) are both up about 19% year-to-date, while more aggressive funds like the iShares MSCI China Small-Cap ETF (ECNS) are up almost 50%.
But things have gotten choppy lately for China stocks. And, unfortunately for investors, it’s because we are back to that old “bad news is good news” feedback loop.
Consider that in mid-May, the flash estimate of China PMI — the purchasing manager’s index that is a widely accepted measure of industrial performance — looked to be shrinking for the third straight month.
That was bad news … and China stocks rallied nicely on the news, in hopes that it meant continued stimulus.
But that was just a flash estimate, and the actual China PMI numbers released today show a mild expansion after a rough start to the year.
That was actually good news … so China stocks naturally sold off on concerns the stimulus train was out of steam.
It can be a confusing roller coaster to ride, but the bottom line is that investors have been banking on easier monetary policy and big Beijing handouts to inflate the stock market there. Though that has happened year-to-date, with The People’s Bank of China cutting key interest rates three times since last November, the million dollar question is whether the moves will continue or reverse course from here.
And while there may be a bit of runway left for stimulus in china, unfortunately, most of the money has already been made on the China trade.
Be Wary of China Stocks Here
Valuation matters, and China stocks have already been re-inflated to a significant degree in anticipation of future growth. One recent report calculates Chinese tech stocks are trading at more than 200 times forward earnings!
In addition, the recent enthusiasm over China ETFs and Chinese stocks to start the year has made for quite a frothy scene. For instance, a recent fund flows report calculates that China ETFs listed worldwide enjoyed $4.2 billion worth of inflows, right before a 6.5% correction last Thursday.
According to Barrons, “China ETF inflows drove what was the biggest week for Asia-themed mutual and exchange-traded funds in 15 years.”
That kind of mad rush to China stocks should be a warning sign, particularly considering how ill-timed it was.
Of course, China stocks have been rallying a bit since the Thursday declines … so maybe those dip buyers are actually the smart ones. But keep in mind that if you’re leery of the continued bull market in the U.S., China is not exactly a bargain alternative.
The Shanghai composite has soared more than 130% in the last year, surpassing Japan to become the world’s third-largest stock index by market cap!
Throw in the fact that one of the world’s leading stock market index makers, MSCI, is debating a change to its emerging market formula that may allow for so-called China A-shares to be included in its indices — and thus a host of institutional portfolios, from all-world large cap funds to specific China ETFs and everything in between.
Discretion is the better part of valor here, considering the big run-up and the risk for a big move down. While it’s tempting to view the big run-up in the region and want to share in the momentum, it’s best to steer clear of China stocks and China ETFs for the time being until the dust settles.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP.
