Chinese Stocks Are in a Slump—and Value Investors Are Excited
While U.S. stocks have soared, those of Chinese companies have tumbled. Some investors are sensing an opportunity.
Investors in Chinese stocks used to bet on growth. Now, they are hunting for bargains.
Portfolio managers say that investors who are still eager to get exposure to China are increasingly turning to value investing. That is a style of stock picking that focuses on finding shares trading below what they are really worth—based on several different measures—rather than looking for companies with big growth potential.
The shift in emphasis from growth to value reflects the stark change of fortunes for China’s economy, which is faltering after years of breakneck growth. Exports and manufacturing have weakened this year, the housing market is in a funk and consumer prices have moved into deflationary territory. While U.S. stocks have surged this year, the MSCI China Index, a broad gauge of Chinese shares, is down more than 7%.
“During economic down cycles when everyone’s more pessimistic, investors turn to deep-value stocks, meaning stocks with relatively low valuations but with good cash flows and dividend payouts, and we’ve been seeing that in China since last year,” said He Xi, portfolio manager of Nous Capital China Value Fund.
Growth stocks in China performed better than value stocks for decades, said Nuno Fernandes, partner and equity portfolio manager at Boston-based GW&K Investment Management. But since February 2021, they have started to do a lot worse, he said.
The downturn in China’s economy and its stock market means even companies that once seemed natural growth plays are attracting value investors.
Alibaba Group, the giant Chinese internet company, was one of the major success stories of China’s decadeslong economic boom. But its U.S.-listed shares have lost almost two-thirds of their value since the end of 2020, when Beijing launched a yearslong regulatory crackdown on internet companies. Its shares are now trading at a price of around 10 times forward earnings, according to FactSet. Walmart’s shares trade at around 23 times forward earnings.
“Alibaba is now both a value stock and a growth stock,” said Colin Liang, a portfolio manager focused on China at Redwheel, an asset manager.
Ryan Cohen, known as a meme-stock investor for his bets on GameStop and other companies, has taken a stake worth several hundred million dollars in Alibaba, The Wall Street Journal previously reported. He wants the company to buy back stock, which would help increase the price.
Fund managers said social-media giant Tencent is another example of a stock with both growth and value characteristics. The company’s stock-market value jumped by half in 2020 but has tumbled since then. It lost a quarter of its value last year, and is now trading at a price of around 17 times earnings.
“These are very high quality businesses that are very undervalued at this point versus what we consider to be their intrinsic value,” said Matt Wacher, chief investment officer for Morningstar Investment Management, Asia-Pacific.
Assets at funds that focus on Chinese value stocks rose by $2 billion in the second quarter to hit around $11 billion, according to data from Morningstar. Investor flows into these funds were worth around 18% of their assets, the biggest percentage move into Chinese value funds since late 2016.
The debate between value investors and growth investors goes back at least a century, and appears to be explained in part by genetic predispositions. Some investors prefer the safety of companies that have reliable earnings, plenty of cash and stable business models; others get excited about finding tomorrow’s success stories today.
The risk for investors who favor cheap stocks is ‘the value trap,’ a term for stocks that look too cheap to ignore—but stay that way even after you buy them.
Foreign investors have become much more cautious about investing in China this year. Small investors inside the country are also nervous.
Chinese regulators attempted to stem the stock market’s slide with a series of measures announced on Sunday, including a big cut to stamp duty, the tax charged on each stock trade. That sparked a big rally when Chinese stocks opened on Monday, but most of the gains had fizzled out by the closing bell. Investors and analysts say clearer steps are needed to address China’s biggest problem—its faltering economy.
But despite its problems, China is still likely to be one of the fastest-growing major economies in the world this year, ensuring that plenty of investors are still looking for the best way to play the country’s $12 trillion stock market.
Some foreign fund managers are buying value stocks because their investment mandates force them to have some China exposure but they want to take a conservative approach to hitting those targets, said Ken Wong, Asian equity portfolio specialist at Eastspring Investments. They will do that by investing in value stocks or the shares of state-owned enterprises, he said.
“Can you completely avoid investing in China? No, you can’t. Investors will park their assets into value or SOE stocks until the signs are pointing in a more positive direction,” he said.
If China’s economy starts to improve, investors will shift back to growth stocks, said Wong. The economy is likely to undershoot the government’s official 2023 growth target of roughly 5%, according to economists at Barclays, Citi and UBS, all of which have recently cut their estimates for China’s economic growth.