Why T. Rowe Price Says Dump US, Buy China Stocks

As the trade war between the U.S and China rages on, investors may find bargains in Chinese stocks. “China is the one [region] where we have a preference because of valuation and because of the expectation that Chinese stimulus can provide some uplift to earnings,” as Thomas Poullaouec, the Hong Kong-based head of Asia Pacific multi-asset solutions for T. Rowe Price, the mutual fund giant headquartered in Baltimore with over $1.1 trillion in assets under management (AUM), in remarks to Bloomberg.

T. Rowe Price sees decelerating earnings growth among U.S. stocks, making them increasingly expensive. Meanwhile, the Shanghai Composite Index gained about 9% over the past month, leading its global peer group, Bloomberg notes. By contrast, the S&P 500 Index (SPX) rose only about 2%, and many investment strategists are reducing their recommended allocations to U.S. stocks.

“Bottom line is, we are bullish on Chinese stocks,” as Justin Thomson, chief investment officer (CIO) of equity at T. Rowe Price in Baltimore, told the South China Morning Post. “Investors are focusing on China’s domestic-oriented companies with less exposure to trade war gyrations and more exposure to the Chinese consumer as the government is likely to use policy as a tool to stabilize and stimulate consumer demand,” as Jonathan Brodsky, founder of international-focused Cedar Street Asset Management, told Barron’s.

Chinese consumers are buying more from local companies, rather than U.S. firms, in response to the trade tensions. These U.S.-listed Chinese consumer stocks posted big gains since being recommended in Barron’s in early August: iQiyi Inc. (IQ), up 9%, Weibo Corp. (WB), up about 35%, and Pinduoduo Inc. (PDD), up about 60%. Additionally, the Xtrackers Harvest CSI 300 China A-Shares ETF (ASHR), a proxy for mainland Chinese stocks, is up roughly 9% during the same period, versus a gain of about 5% for the S&P 500, the column adds.

Meanwhile, China has created the so-called STAR Market, designed to compete with the Nasdaq. The strategy is to have IPOs from innovative Chinese startups listed there rather than in the U.S. or Hong Kong.

“Recent selling in both Chinese and U.S. tech stocks has been painful, but we see it potentially creating more attractive entry points for long-term investors,” wrote Kate Moore and Lucy Liu, analysts with BlackRock, as quoted by the SCMP. “We believe valuations may be nearing bottom. For those with a long-term mindset and stomach for short-term volatility, we believe it may be an opportune time to step in,” they added.

While the S&P 500 has shot up by about 340% from the trough of the last bear market in March 2009, the Shanghai Composite has posted a modest gain, in local currency terms, of only about 39% during the same period, per Yahoo Finance. During this period the Chinese yuan has depreciated by about 4% versus the dollar, per Macrotrends.net. Translated into dollars, the Shanghai Composite is up by only about 34%. Current P/E ratios are19.5 for the S&P 500 and 14.6 for the Shanghai Composite, per Bloomberg.

“S&P earnings are unlikely to grow at all over the next twelve months,” Morgan Stanley warns in a current report. Slowing revenue growth, largely due to excess inventories, ongoing trade tensions, and rising costs, particularly labor costs, are among the factors that they see exerting downward pressure on profits. They see the S&P 500 stuck where it is today, at 3,000, through the rest of 2019.

Regarding Chinese stocks, there also are reasons for caution. In August, Chinese exports were down by 1% year-over-year (YOY) and imports fell by 5.6%, according to another Barron’s report. China’s producer price index (PPI), an indicator of business profitably, dropped by 0.8% YOY, its biggest decline since 2016.

Inventories of manufactured goods are piling up, as U.S tariffs and weak economies in Europe crimp Chinese exports. This, in turn, is forcing price cuts that reduce profits and make it harder for Chinese companies to pay down debt, possibly increasing an already-record number of corporate defaults, observes Rory Green, an economist at TS Lombard, in remarks to Barron’s.

Meanwhile, the services industry in China, which accounts for about 60% of GDP and most new jobs, also is in slowdown. Wage growth also is slowing, and Chinese companies have avoided layoffs by cutting work hours and benefits. This bodes ill for consumer spending in China, and thus consumer stocks, as well as the general economy, given that private consumption, as China calls it, was 39.4% of GDP in 2018, per global economic research firm CEIC.