Monday, December 12, 2016

China's Investors Aren't Afraid Of Trump

By Matthew A. Winkler
The Bloomberg View
December 12, 2016

The world can only wonder whether President-elect Donald Trump will fulfill his campaign promise to impose a 45 percent tariff on Chinese-made goods bought in the U.S.

What's already clear, though, is that investors inside the No. 2 economy, unlike their American counterparts, are undaunted. Even after Trump's upset victory last month, their appetite for the country's favorite companies is growing, as long as they can trade shares of them in U.S. dollars. That's a big bet that the financial glue sealing a decades-old symbiotic relationship isn't dissolving just yet.

No nation does as much business with the U.S. as China, accounting for almost 17 percent of total American trade, according to data compiled by Bloomberg. The stock market benefiting most from this booming commerce is the Guangzhou-based E Fund Hang Seng China Enterprises Index, one of 265 global exchange-traded funds focused on China and holding the shares of 40 major companies also trading in Hong Kong dollars, which track U.S. dollars. For Chinese investors, the E Fund HSCEI ETF is the closest thing to owning American currency. They poured $549 million into the fund this year, or 67 percent of its total assets, the most of any Sino ETF. Their investment is paying off with a return of 10 percent, rivaling the performance of the Standard & Poor's 500 Index.

As China's economic growth rate slowed from 10.6 percent in 2010 to 6.7 percent this year, money flowed out of the country. The renminbi depreciated 6 percent to an eight-year low through 11 months of 2016. That helps explain the Chinese preference for publicly-traded equity in dollars amid forecasts that the renminbi will weaken almost another 3 percent in 2017.

Trump's election on Nov. 8 accelerated the trend. A day later, the flow of money into the E Fund HSCEI ETF was the most since June 24, when Trump toured his Turnberry golf course in Scotland and celebrated the British vote to leave the European Union as "a great thing." Brexit caused the pound to plummet as much as 19 percent by the middle of October while the euro lost almost 5 percent of its value between May and late July. Such volatility increased demand for dollars as a refuge for investors.

Across the Pacific, American investors are showing nothing but disdain for Chinese shares. Slowing growth, a relatively opaque economy and Trump's threat to declare China a currency manipulator helped make the San Francisco-based iShares China Large-Cap ETF, which holds 50 companies also traded in Hong Kong dollars, the least popular among the 265 China-focused ETFs. So far this year, more than $1.7 billion, or 32 percent of its total assets, have fled the fund. On Nov. 9, the same day the Chinese rushed into the Guangzou ETF, the iShares China suffered its biggest withdrawal since June 13.

Where Americans see peril, Chinese see opportunity in the nation's bellwether companies. Consumer staples, the best-performing industry with a yuan-based total return (income plus appreciation) of 15 percent this year, remain the favorite measured in dollars. They returned 8 percent compared to a 0.03 percent gain for the MSCI World/Consumer Staples Index. These Chinese companies are a bargain because investors still are paying a 10 percent discount on a price to earnings basis in 2016 compared to their global peers. During the past five years ending in 2015, the same companies sold at an average premium of 20 percent, Bloomberg data show.

The outlook brightens for the 20 Chinese firms that make up the consumer staples industry amid forecasts for world-beating average revenue growth of 3.3 percent in 2016 and 13.3 percent next year. The 123 companies in the MSCI World Staples Index, by comparison, will see sales increases of 2.2 percent this year and 5.1 percent in 2017, according to Bloomberg data.

Energy companies, which returned 0.4 percent as China's top-performing industry this year, have a similar relative value. Since June 2014, when the price of oil declined 50 percent, China energy firms and their global competitors became less profitable, measured by their ebitda margin, or how much a company can turn revenue into earnings before interest, taxes, depreciation and amortization expenses. Chinese profitability held at 13 percent while the rest of the world's ebitda margin declined to less than 7 percent. When measured on a price-to-cash flow basis, an indicator of value commonly used by the energy industry, Chinese firms are trading at a 45 percent discount to their peers -- meaning they're likely to go up reasonably soon.

To be sure, many analysts say Chinese energy is owned by the government and therefore more resistant to oil's falling value and less likely to profit when the oil price increases. But energy companies outside China already are expensive based on their cash flow ratios, so China remains cheap by comparison.

Chinese investors can rest assured that even during the country's slowdown, China's growth will remain at the top of the Group of 20 nations this year and will be No. 2 during the next two years, according to data compiled by Bloomberg. The estimated 6.7 percent gross domestic product growth in 2016 is about $730 billion, or equivalent to the Netherlands economy. If China grows 6.4 percent in 2017, the average of forecasts compiled by Bloomberg, it will be $670 billion larger next year, an amount greater than the economy of Switzerland.

For all the anxiety outside China about what a President Trump may do during the next four years to alter the relationship between the No. 1 and No. 2 economies, there is the confidence inside China that comes with a 5,000-year-old civilization.


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