Taking advantage of short-term market volatility and oversold asset prices is the key to building attractive long-term returns this decade. Higher interest rates this decade will weigh on index returns. And ‘stickier’ inflation will require a higher real return to maintain purchasing power. Buying into volatility, when irrational market sentiment drives prices too low, will be needed to boost returns in otherwise constrained equity markets from here.
None of this is new, of course. Savvy investors have a knack for buying when others sell and embracing market volatility rather than avoiding it.
More retail investors will need to do the same this decade. Unlike in the previous decade, when near-zero rates drove market momentum, investors will have to work harder to deliver attractive real returns. Index investing won’t work nearly as well this decade. Timing the market will be more important.
Start with this week. As I wrote this column, the S&P/ASX 200 Index was off 2.1% – its largest intraday fall since March 2023. Higher-than-expected inflation in the US and heightened tensions in the Middle East spooked investors.
Neither event surprises. What did surprise this week was China’s GDP growing faster than expected on fresh government stimulus. I’ve had my eye on oversold Chinese equities for a few weeks, so the news piqued my interest.
Chinese GDP grew 5.3% in the first quarter from a year earlier, beating market estimates. However, March retail sales and industrial output missed forecasts, suggesting China’s economy might be slowing further.
The headline GDP number belies China’s ongoing real-estate crisis that is hurting other industries, such as building materials. China must do more to get its growth on track, after a disappointing post-COVID recovery.
Nobody should doubt the extent of China’s short-term economic malaise or the long-term problems it faces from a rapidly ageing population. Its economy will likely worsen before it improves, judging by this week’s data.
But every asset has its price. The SSE Composite Index, the main barometer for stocks on the Shanghai Stock Exchange, is down almost 11% over one year. The index has fallen for the last few years as China’s economy has slowed. In contrast, key equity markets in the West trade near record highs.
The average trailing Price Earnings (PE) multiple on the Shanghai Stock Exchange is about 12 – near its lowest point in a decade. In 2018, the average PE was closer to 20. A number of Chinese stocks are on single-digit PEs.
Several market strategists and emerging-market experts in the past year have argued Chinese equities have bottomed, only to watch them fall further. But after such heavy losses, Chinese equities look more attractive.
AMP Chief Economist Dr Shane Oliver recently wrote: “… while Chinese economic growth is not as strong as it used to be, it seems to be hanging in there around 5% despite its property slump. While the iron-ore price has recently fallen, it remains in the same range it’s been in for the last two-and-a-half years and well above many assumptions. Furthermore, the copper price appears to be breaking higher, which is normally a sign of strength.”
Contrarians in Chinese equities must be able to tolerate ongoing heightened volatility and the potential for further short-term losses. Few investors ever pick the bottom in equity markets, particularly China’s. Regulatory and currency risk adds to the uncertainty. This is not a market for risk-averse investors.
Moreover, Chinese equities should only have a small portfolio allocation, probably less than 5%, for most investors. Caveats aside, here are two Exchange Traded Funds (ETFs) on ASX to gain exposure to Chinese equities.
- iShares China Large-Cap AUD ETF (ASX: IZZ)
The iShares China Large-Cap ETF provides exposure to 50 of the largest and most liquid Chinese companies listed in Hong Kong. Its top stock weightings include Alibaba Group Holdings, Tencent Holdings and China Construction Bank.
Over three years, IZZ has a negative annualised return of almost -14%, showing just how far Chinese equities have fallen in the past few years. Over 10 years, the annualised return is a paltry 1.86%. So much for China’s economic miracle, at least for investors in Chinese equities.
At end-March 2024, IZZ traded on a trailing PE of 11.1 times, a price-to-book ratio of 1.12 times and a yield around 3%. That’s getting low for China’s top companies, in an economy still growing at over 5% annually.
In contrast, the average PE multiple for the S&P 500 Index in the US is almost 26 times and the price-to-book ratio is 4.5 times.
Chart 1: iShares China Large-Cap ETF (ASX: IZZ)
- VanEck FTSE China A50 ETF (CETF)
CETF provides exposure to a diversified portfolio of China’s 50 largest companies in the mainland Chinese market. CETF provides the only dedicated China-A share market benchmark exposure via ASX.
About 29% of CETF is invested in Chinese financials, followed by consumer staples at 28% and industrials at 11%. There appears to be minimal direct real-estate exposure, judging by my review of the CETF’s stock holdings.
CETF has fallen from $80 a share in early 2021 to $51. Like other ETFs over Chinese equities, CETF has been affected by the slump in Chinese equities, China’s sluggish economy (by its standards), regulatory risk and the country’s poor post-COVID performance.
Over three years, CETF’s annualised return is almost -10%. Over five years, the annualised return is -2.9%. Over short and long periods, CETF, like other Chinese equity ETFs, has destroyed wealth since its inception in June 2015.
CETF’s exposure to mainland Chinese equities (through China-A share market exposure) gives the ETF a higher risk profile. But it also provides scope for opportunities for experienced investors who understand the risks of this market.
At end-March 2024, CETF traded on an average PE multiple of 12 times and a yield of 3%, much like IZZ.
Of the two ETFs in this column, I prefer IZZ because of its exposure to Hong Kong-listed equities rather than mainland China equities.
Both ETFs have an annual management fee of 0.6%, and similar share-price charts that will frustrate existing investors and possibly attract the interest of experienced contrarians who know the best time to buy unloved assets is when they fall even further during short-term bouts of market volatility.
Chart 2: VanEck FTSE China A50 ETF (CETF)
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation, or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation, and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at April 17, 2024.
