China ETFs: Value Plays? Maybe
There are some certainties in life, death and taxes among them. These days, other certainties include the seemingly never-ending spate of disappointing Chinese economic data and the subsequent calls that stocks in the world's second-largest economy are inexpensive.
With Chinese economic growth slowing, it could be time for investors to adjust their views on stocks there to value propositions from perceived high-flying growth plays. Yes, China's economic growth, though disappointing compared to the double-digit pace just a few years ago, is slowing. However, it is still above the global average, but that does not mean Chinese stocks, broadly speaking, are growth stories.
Year-to-date, the iShares China Large-Cap ETF (NYSE: FXI) and the iShares MSCI China ETF (NYSE: MCHI) are down an average of 10.2 percent. The Guggenheim China Small-Cap ETF (NYSE: HAO) is off 2.4 percent. Those performances indicate few investors have taken the bait on supposedly good values.
This year's disappointment does not mean that investors should throw in the towel on China as a value play.
"When an economy is as big as China's is now, you would expect its growth to slow," said iShares Global Chief Investment Strategist Russ Koesterich in a note. "In my team's opinion, China has reached the size where investors should be focusing mostly on whether China looks cheap relative to its fundamentals. In other words, as a maturing economy, China is more like Microsoft today than Microsoft two decades ago. While China's growth rate is still important, it should be of secondary importance to investors, assuming it doesn't crash."
Koesterich's Microsoft (NASDAQ: MSFT) analogy is a relevant one because if recent data are any indication, gone are China's halcyon days of 10 percent economic growth, but that does not mean ETFs such as FXI and MCHI cannot reward investors down the road. Microsoft, now a value stock, has gained over 15 percent in the past two years and the company's dividend has more than doubled in the past five years.
Speaking of dividends, China is now the largest dividend payer among emerging markets with a dividend stream of $27 billion, according to WisdomTree.
Related: Use This ETF For China Dividend Growth.
"When you view Chinese stocks from the value perspective, they look cheap relative to other emerging markets and the broader market," wrote Koesterich. "For instance, the MSCI China index is currently trading at below 9x forward earnings, versus 10.6x for the MSCI EM index and nearly 15x for MSCI World index."
The average P/E on FXI and MCHI is about 13, implying those ETFs trade at noticeable discounts to the iShares MSCI Emerging Markets ETF (NYSE: EEM) and the comparable Brazil and South Korea ETFs, just to name a pair.
"At these valuations, Chinese equities look like a good long-term value considering that it's still growing faster than developed countries and other EM countries, including the rest of the BRIC countries," said Koesterich.
Investors that are still looking for growth from Chinese equities need not fret. This year's best China ETFs are those with heavy exposure to Chinese tech stocks. Those funds include the PowerShares Golden Dragon China Portfolio (NYSE: PGJ) and the Guggenheim China Technology ETF (NYSE: CQQQ). PGJ's P/E is almost 26.5, but the fund has surged 25.3 percent this year.
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