Look Out… The Sleeping Dragon Awakes
China has endured a steady drumbeat of criticism over their economic policies over the past couple of years. And Chinese stocks have become the favorite target of opportunistic short sellers.
However, I think investor sentiment on China has finally swung too far to the bearish point of view. And as history has shown time and again…
Once an idea becomes conventional wisdom, that idea has run its course.
I first began seeing signs of cracks in the bearish views on China in the fourth quarter of last year. And I penned a couple of articles urging investors to take advantage of the situation by snapping up quality Chinese stocks at bargain prices.
And so far, my optimistic viewpoint has proven correct.
The Shanghai Composite Index has gained nearly 5% year-to-date.
But the best part is, it’s just the beginning…
As I predicted last year, the Chinese government has begun taking steps to stimulate economic growth. The first step was a lowering of the reserve requirement ratio (RRR) for Chinese banks in November 2011. A decision that has since been repeated two more times.
Lowering the RRR enabled Chinese banks to increase lending to the private sector. And these stimulative measures are finally starting to achieve their desired effect.
The most recent figures show lending in May topped analysts’ estimates by 13.3%.
What’s more, new lending in May totaling 793.2 billion yuan ($125 billion) jumped 16.3% from the 681.8 billion yuan lent in April. This is yet another bullish sign for China.
It means the pace of new loans in China is accelerating.
But as I pointed out in my most recent article on China, Ignore The Naysayers… Buy Chinese Stocks!, merely lowering the RRR won’t be enough to create sustainable economic growth.
In fact, China’s GDP grew at lower year over year rate of 8.1% in the first quarter of 2012. And it’s expected to have shrunk again in the second quarter to around 7.7%.
As I said in the above article…
“Clearly, more stimulus is needed. This can mean only one thing. The Chinese government has to take their strategy for loosening monetary policy to the next level. That’s right… interest rate cuts.”
Well… it looks like China’s leaders heard my pleas.
Last week, for the first time in over three years, the Chinese government lowered interest rates. On June 7th, China announced a 0.25% cut which lowered the short-term rate to 6.31%.
And there’s still plenty of room for more cuts if needed.
The primary concern about loosening monetary policy is that it can spark inflation if not done properly. However, the most recent data show inflation is nothing to worry about right now.
Inflation fell to just 3% in May… the lowest level in two years and well below the government’s 2012 target of 4%.
Now here’s the key…
China’s efforts to loosen monetary policy are bullish for Chinese stocks. Lower rates should encourage Chinese businesses to borrow money needed to expand their businesses. And once these investments are made, we should see China’s economy expand and corporate earnings rise.
And I’m not the only one who thinks so…
Billionaire money manager, Ken Fisher, recently said he turned bullish on Chinese stocks in the fourth quarter of 2012.
According to Bloomberg, Fisher believes “China will loosen monetary policy for another 12 to 18 months.” And as a result, he is “overweight China and optimistic on China relative to both emerging markets and the world as a whole.”
With over $45 billion in assets under management, Fisher is not one to make rash decisions about where he invests his clients’ money.
Credit Suisse is also singing a bullish tune about Chinese stocks.
The day after China’s rate cut was announced, the global investment firm told Bloomberg…
“Chinese stocks are set to climb 36% over the next year as valuations drop below their decade average and the government further loosens monetary policy to bolster economic growth.”
Whether you agree with these experts or not, the numbers don’t lie. Chinese stocks are trading at near-bargain basement prices.
For example, The Shanghai Composite Index is currently trading at just 1.74x book value. That’s well below the average price to book of 2.38x since 2003.
Furthermore, the average P/E ratio for stocks in the Shanghai Composite stands at 9.9x. That’s up just a bit from the record low P/E of 8.9x set in January. But it’s still well off the five-year average of 17.8x.
Bottom line…
The sleeping dragon is finally awakening from a multi-year slumber. As China continues to loosen monetary policy over the next year or two, we’re going to see money pour into Chinese stocks and drive valuations higher. If you’re looking for big potential gains in stocks, take a closer look at China now before they take off.
Profitably Yours,
Robert Morris
Category: Foreign Markets
