After a brutal correction in both prices and valuations it is time to get long(er) China geared Hong Kong listed equities. I believe the timing is right because the single largest risk factor, inflationary pressure, is in the process of peaking, and is likely to abate moving forward. China growth has been continuing at a 9% clip and I believe this growth rate is likely to slow gradually. Through a combination of currency appreciation, higher real interest rates, and credit constraints (the growth rate of credit) China will start the gradual process of focusing on domestic demand. Valuation is on the side of real investors as the H-Shares (HSCEI index) are at ex-crisis lows and sub 10x forward earnings. This is a 30%-40% valuation discount to what is “average” over the past decade, inclusive of the financial crisis in that average. With inflation peaking and growth still strong investors can participate in re-rating returns and fast earnings growth. Investment in Hong Kong avoids the problems that were notable in the financial press related to “fraud cap”. The Hong Kong listed companies have top auditors, and have met Hong Kong Stock Exchange listing requirements which are amongst the toughest in Asia.
In terms of investment focus I strongly favor companies in Hong Kong which are geared towards domestic demand in China and not geared towards export demand elsewhere in the world. The domestic Chinese growth story, particularly China Consumption, will be the net beneficiary of government re-adjustment and this sub-space will grow faster than GDP over many years. China Consumption as a % of GDP is in the mid 30% and will be much higher than this in 5-years and 10-years time. I will be writing about the secular Chinese Consumption story often in future posts, and I will also have individual stock ideas which are listed on the Hong Kong Exchange in my focus investment ideas. The costs of investing around the world have declined dramatically for both institutions and individuals and all investors should be setting up investment accounts which provide flexible global investment opportunity. The following valuation charts will focus on the entire market (either the H-Shares or MSCI China) but an ETF that investors could own to invest in these themes is the Global X China Consumer ETF (CHIQ). Again I will be highlighting individual securities within this ETF (and others) going forward but for now I want to introduce the theme when the timing seems right to me. I’ll add the CHIQ as a focus investment at $16.31 with a 6-month target price of $24. The individual stocks in Hong Kong will pay higher dividend yields and can be owned in Hong Kong Dollars (I prefer owning in HKD despite a USD/HKD peg because if the peg were to break i would expect a sharp appreciation in the HKD).
From a valuation standpoint the following charts demonstrate the value of the overall market:
MSCI China Forward P/E Band
Forward P/E Bands – (Discount)/Premium to historic averages
Forward P/E Bands – HSCEI at an even steeper discount:
- Mean HSCEI forward P/E is 14.5x and is currently 9.2x
China Total Inflation Trends:
- The inflation compares start to cycle higher rates of inflation in September and especially so in October and November.
- Given crude energy and overall commodity pricing dynamics the headline China inflation rate is set to crest.
- Inflation turning around will lead to multiple expansion for Hong Kong listed equities.
China Core Inflation Trends:
- China inflation trends ex-food & energy look much closer to the rate of inflation in the US!