Should You Buy China ETFs on Stimulus Bet? - ETF News And Commentary

Concerns over the Chinese economy had reached a delirious pitch at the beginning of 2014. The issues, which surfaced in 2012 and led to a hard landing problem for the economy, heightened with the country's economic growth slowing down to a 18-month low in the first quarter of this year (read:

).

Faltering demand from key export markets like Europe, a shaky domestic market, slowdown in the manufacturing industry, less hot money flows in the wake of QE wrap-up in the U.S. and credit concerns were at the root of the problem. Factory activity data was downbeat for the first four months of the year. Hazards in the financial market tossed up some more fears about a slowdown.

To add to these concerns,  the World Bank cut its 2014 growth forecast for the world's second biggest economy  to

from 7.7% in early June, though it kept the forecast for 2015 unchanged at 7.5%.

The Chinese authorities however did not sit idle.

To lift the cloud over the economy, China planned a mini-stimulus package mainly targeted at

and other construction investment and to provide tax relief for small enterprises. However, all its policy measures were small in scale.

Through small measures, China made it clear that it actually seeks to bolster its domestic growth and reduce focus on exports. Slashing the reserve requirement ratio for rural banks, boosting the rural capital market and focusing on innovative rural financial products hinted at the transition. 

Thanks to this stimulus, the economy had also been showing signs of improvement with

growth in Q2, exceeding analysts' expectations, and 7.4% in Q1. Not only this, China trade surplus peaked to a

in July from the dual impact of rising exports and falling imports. The trend was intact in August with exports rising about

and imports dropping about 2.4%.

However, just as investors started gaining confidence in the Chinese market, some unfavorable economic data have once again slackened the slowly building investor faith in China investing.  Investors should also note that fall in imports for two successive months hint at the sluggish domestic consumption.

An index of Chinese manufacturing published by the National Bureau of Statistics slipped from a

-month high to 51.1 in August. Surprisingly, such an offhand number still represents the second highest industrial production data this year. New orders, production and export orders exhibited

in the month.

Average home sales in China also declined in August for the fourth successive month resulting in increased inventory of unsold apartments. Prospective home-buyers as well as factory owners were possibly hurt by the credit crunch issues. Non-performing loans were on the rise (read:

).

The government is putting in a lot of effort to arrest shadow-banking activities and money laundering from mainland China to other peripheral destination like Macau. However, one school of economists believe that the government's excessive focus on anti-corruption activities in fact rein in GDP growth. In such a lackluster scenario, only the service data ─ which bounced back in August─ boosted investors' mood (read:

).

Interestingly, any bad news has become good news for China. The more the nation is coming up with dampened numbers, the more the speculation for larger monetary stimulus is making the rounds. Market participants started to consider that the Chinese government needs to opt for a more accommodative policy to attain a 7.5% official growth rate this year.

If we go by a recent

, several economists voted for the possibility of a reduction in the reserve requirement ratio (RRR) by 50 basis points between this October and next March while only one out of 15 analysts expects a slash in the interest rate.

The central bank's recent cut of the re-lending rates for agricultural loans by 100 basis points, sanctions of a

yuan ($3.3 billion) re-lending quota to shore up agriculture and the relaxation of home buying rules in

─ a Chinese city buckling under pressure from over-supply of homes ─ give cues of further easing.

The biggest ETFs on China –

FXI

added 7.7% year to date,

(

was up 6.3%,

was up 6% and

PGJ

advanced 10.3% (read:

). 

Not only this, investors poured money into China ETFs at the best clip in about two years on hopes of a further stimulus program, as per a

. Since August 1, 2014, FXI witnessed $505.79 million in inflows while as much as

million was injected in MCHI. GXC hauled in $65.29 million in inflows (read:

).

There is no doubt that the growth engine of the Chinese economy has cooled down. However, any announcement of stimulus measures, though we do not expect a massive one soon, will likely heat up the market.

Chinese equity ETFs are undervalued at the current level with the biggest ETF FXI trading at a P/E (ttm) multiple of 8 against the broader emerging market ETF

's P/E (ttm) multiple of 12. However, to ride out the potential surge in China ETFs, investors need to stay hawkeyed. FXI and GXC currently have a Zacks ETF Rank #4 (Sell) while MCHI and PGJ have a Zacks ETF Rank #3 (Hold).

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