For contrarian-minded investors, stockmarket falls offer inexpensive entry points, writes David Liddell.
There were signs in the last quarter of 2018 that the growth/technology stocks that had led the bull market were flagging. However, market momentum remains strong, and global consumer brand companies such as Unilever and Diageo are still loved.
A lot of this popularity has to do with anticipation that increasing amounts of high-margin brands will be sold to Chinese consumers. The Chinese economy, at least in terms of official statistics, has continued to grow at a reasonable rate. The OECD forecasts GDP growth in China of 6.3% in 2019 and 6% in 2020. Admittedly, growth in China is slowing, but this comes after the economy has more than doubled in size over the past 10 years.
In stark contrast, comparable rates of GDP growth for the US are forecast to be 2.7% and 2.1%. Yet the Chinese stockmarket has tanked, with the MSCI China index down almost 22% in dollar terms over 2018.
Is it time to look again at China as a contrarian opportunity? The downside risks are evident: potentially dodgy corporate governance, political manipulation, and high levels of consumer and corporate debt. Moreover, its trade war with the US appears to be damaging its economic growth, with the latest PMI survey showing weakening manufacturing demand. But, of course, much of this should already be priced into share values.
On the positive side, China’s economy is still fairly strong, its middle class continues to grow and its public sector debt-to-GDP ratio remains low compared with most developed economies. The Chinese government has in the main proved adept at turning on the stimulus taps when needed – as well as, at the start of 2019, reaching the dark side of the moon!
So where are valuations? As at the end of 2018, we estimate MSCI China to be on a dividend yield of 2.4% and a forward price/earnings (p/e) ratio of about 10 times. If the economic growth rates are even half right, this makes China attractive. The snag is that these valuation statistics hide wide variations between some of the high-flying, US-listed technology companies, which carry high valuations and the lowly valued part-state-owned enterprises. Even though their p/e valuations remain elevated, internet stocks such as Tencent (down 27%) and Alibaba (down 25%) had a rough ride in 2018 and now could be a reasonable entry point.
Fidelity China Special Situations (FCSS) is perhaps the most obvious investment trust offering exposure to China. It launched to great marketing fanfare under investment guru Anthony Bolton in 2010, but struggled to make progress. Nevertheless, the idea behind it – of gaining exposure to China’s rapidly growing band of consumers – has proved sound. Current manager Dale Nicholls (appointed in 2014) has reaped the benefit. From a low point of 72p in August 2012, the trust’s price rose to a high of 264p in June 2018, with its NAV more than trebling since launch. Since then the Chinese market has fallen away quite rapidly, partly because trade tariff wars have come into the spotlight. At the time of writing (start of 2019), the trust is down by 30% from its 18 June high and stands at a discount of 10%.
This trust is always likely to be quite volatile, because of the nature of the Chinese market and the use of gearing, which is currently at 22%. It also has a reasonably concentrated portfolio, with the top 10 representing 49% of the portfolio. It has more or less index weightings in Tencent (15.8%) and Alibaba (11.3%), so the fate of these two will be quite influential in terms of outcomes.
For a slightly different exposure, there is JPMorgan Chinese (JMC), although it is still geared at 18%. JMC underperformed the Fidelity trust by just over 40% during the five-year period to the end of 2018 in NAV terms, possibly because it rode the technology/internet wave less forcefully than Fidelity and had higher exposure to China A shares (domestic shares).
Its discount is similar to FCSS’s at 10.1%. Top 10 holdings represent 47% of the portfolio, with 10.1% in Alibaba and 9.1% in Tencent. It has 28% exposure to China A shares, compared with just 10% for Fidelity. It could be a relative beneficiary of institutional investors generally moving their exposures into A shares.
The German market was also a significant casualty in 2018. The MSCI Germany index was down 22% in dollar terms. Jupiter European Opportunities – run by long-term manager Alexander Darwall, who has an excellent record – looks attractive on a small discount, as it usually stands at par or a premium. It has 33% of assets in Germany, although this weighting is mainly made up of Wirecard (14.6%) and Deutsche Boerse (7.7%).
David Liddell is chief executive at and a major shareholder in IpsoFacto investor.com, which has approved this research. He may have equity holdings in any or all the stocks listed. The firm offers a two-month free trial of its investment trust advisory service. Visit www.ipsofactoinvestor.co.uk