Since reaching a post-crisis high in August 2009, the Shanghai
Composite Index of Chinese equities has fallen 40 percent.
During that same interim, the S&P 500 has risen 40 percent.
Both indices reached their historic highs in October 2007. But,
whereas the S&P currently sits just 9 percent below its
high-water mark, the Shanghai index is currently 66 percent
below its peak. So, is it now time to consider buying Chinese
First, a little more background. During the two years of 2006
and 2007, the Shanghai Composite Index rose parabolically,
delivering a staggering 350 percent return. At its price
peak, the trailing price/earnings ratio was 44x, compared to
the S&P at 17x at its high price. Clearly, a bubble had
formed in Chinese equities, driven by euphoria over global
growth rates and the voracious appetite for cheap Chinese
imports. A newly minted class of Chinese domestic equity
investors with few other investment options helped to fuel
the rise. But the financial crisis dramatically dulled the
appetite for Chinese imports, and growth in China has slowed
from year-over-year rates of 10.4 and 11.2 percent in 2006
and 2007 to 7.8 percent currently. And many China watchers
believe the actual current growth rate to be well below the
official rate. The third quarter number will be released
later this week and is expected to show a further slowdown to
The steady decline in the Shanghai Composite leaves it with a
current P/E ratio of just 11.5x. The S&P currently is trading
at 14.5x. So, with the excessive valuation having been washed
out, on a relative basis Chinese equities arguably look
cheap. But what are the prospects for improving economic
growth and rising equity prices? The transition to a more
balanced economy with rising domestic demand is a slow
process. Savings rates remain high and the population is
aging. And housing inflation remains an official concern. If
the Chinese economy is still predominantly reliant on its
export industries to fuel growth, improvement is likely to be
slow with the developed world expected to grow at just a 1.5
percent rate in 2013, according to the IMF. The manufacturing
Purchasing Managers Index has dipped below the 50 level in
each of the past two months.
There is little China can do to alter that outlook, which
means that it must look inward. Monetary policy has been
loosened, as bank reserve requirements have been eased and
interest rates have been cut. But the last move came in July
and there is room to do more. Consumer inflation slowed to a
rate of 1.9 percent in September. Domestic demand remains
healthy, but has softened recently. Both the
non-manufacturing PMI and retail sales growth have slowed, as
have loan growth and the money supply.
China is mindful of its fiscal and monetary resources and
their ability to stimulate domestic demand. But it does not
want to repeat the excesses of the stimulus effort following
the start of the financial crisis, which led to wasteful
spending and property inflation. If new stimulus spending is
to come, speculation is that it will follow sometime after
the new political leadership takes over at the National
Communist Party Congress which convenes on November 8. If
further action is taken, consumer stocks will likely benefit.
And if infrastructure projects are targeted, industrial and
materials stocks will benefit as well, including those
domiciled in the U.S. and other countries which enjoy robust
trading relations with China.
The views expressed are as of the date given, may change as
market or other conditions change, and may differ from views
expressed by other Ameriprise Financial associates or
affiliates. Actual investments or investment decisions made
by Ameriprise Financial and its affiliates, whether for its
own account or on behalf of clients, will not necessarily
reflect the views expressed. This information is not intended
to provide investment advice and does not account for
individual investor circumstances. Investment decisions
should always be made based on an investor's specific
financial needs, objectives, goals, time horizon, and risk
The Shanghai Composite Index is a capitalization-weighted
index of all stocks on China's Shanghai Stock Exchange.
The S&P 500 is an index containing the stocks of 500
large-cap corporations, most of which are American. The index
is the most notable of the many indices owned and maintained
by Standard & Poor's, a division of McGraw-Hill.
It is not possible to invest directly in an index.
Investment products are not federally or FDIC-insured, are
not deposits or obligations of, or guaranteed by any
financial institution and involve investment risks including
possible loss of principal and fluctuation in value.
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