Gloom for manoeuvre

PUBLISHED : Monday, 23 April, 2012, 12:00am
UPDATED : Monday, 23 April, 2012, 12:00am


The good news for investors is that the mainland registered its slowest economic expansion for three years with first quarter gross domestic product growth coming in at 8.1 per cent. Indeed the World Bank forecasts that growth for the whole year will be 'only' 8.2 per cent, the lowest figure in a decade.

So why is this bad news good for investors? For a start, wily investors know, or should know, that GDP figures and stock market returns are two very different things.

History shows that when news emerges that economic growth is slowing, markets take fright and share prices tumble. This dynamic played out exactly in the mainland market recently, with the Shanghai Shenzhen CSI 300 Index down about 24 per cent over the past year.

Investors will eventually realise that a weak economy does not necessarily mean weak corporate profits. For example, firms in the United States were reporting robust income gains through 2010 that translated into a stock market surge well before the country's tepid economic recovery kicked in.

But even when bargains are evident, many investors won't take advantage, preferring, as they often do, to buy high and sell low along with the rest of the herd.

The current situation in Chinese markets provides a classic example of opportunity obscured by gloom. The CSI 300 Index closed last Tuesday at a price/earnings ratio of 12.9 times. This compares to a 10-year average for the index of 22.6 times.

The P/E ratio is the share price divided by earnings per share, and it is a widely used measure of a stock's 'cheapness'. By that metric, Chinese stocks are about 43 per cent cheaper than their decade average. Most of the companies on the Shanghai Stock Exchange have released profits for the past year and they show an average profit growth of 17 per cent, according to Bloomberg.

This trails the average of analyst's estimates by some 4 per cent, which may mean that, as usual, the analysts have got it wrong.

Fears are growing that China is heading for a hard economic landing, but this should be music to the ears of savvy investors.

These investors were probably put off by the heady valuations in mainland equities in the early part of the decade, and were then scared off by the sharp market falls in 2010 and 2011.

For such people, Chinese stocks have either been too expensive or the outlook too negative.

At some point they have to make the jump, and today's mix of low prices (measured against historical P/E levels) and strong corporate earnings may be just such a point.

There are plenty of caveats to be issued about playing this market. A black area surrounds property counters, which are prone to asset bubbles and boom-and-bust cycles.

Then there are banks, whose asset valuations remain opaque, and Chinese small-cap stocks, a sinkhole for the basics of good governance.

Yet there is quality to be found, particularly among large-cap stocks with solid businesses, such as large oil companies and infrastructure counters, or possibly insurers. And despite prevailing talk of a downturn, it's worth considering retailers that cater for the still-expanding domestic market.

Much attention is being paid to China's falling exports, yet this does not necessarily mean a downturn for industries associated with exports, such as electronics and machinery, or clothing and shoemakers.

These are expanding production, with any slack from export declines absorbed by domestic demand.

The Chinese stock market remains hazardous and the opportunities that exist today may be short-lived. But this is the nature of equity investment: nothing is good for all times and timing is the key to the profit.

Buying opportunities abound. Ironically, one of the alleged big negatives surrounding the Chinese market - the dominance of state holdings - offers an advantage: new investors can take comfort that the biggest stakeholders will stick with their investment.

Indeed, it is clear that preserving the strength of the stock market and using the state's considerable powers to maintain economic growth are key parts of public policy.

Oh, and by the way, where else in the world could there be gloom surrounding an 8 per cent growth rate?