VALUE for money in the global stock market universe is rare, but if you blink you might lose out.
Until now, the global equity universe, as measured by the MSCI All-Country World Index (ACWI), a market capitalisation-weighted index that measures the equity performance in both the developed and emerging markets is up by 15.5 percent in terms of the US dollar, since the end of December last year. The year 2021 is characterised by divergent stock market performances all over the world, though ranging between -22 percent and +35 percent.
After being one of the top performers in 2020, China’s stock market, however, takes the honours as one of the world’s worst performers in 2021 with the MSCI China Index down by 19 percent. The MSCI China Index captures large and mid-cap representation across China and covers about 85 percent of the China equity universe.
The drawdown in China is even more astounding when it is compared to the MSCI Emerging Markets Index’s -3.3 percent, especially given the country’s weight of about a third in the index.
The reason for the initial sell-off of Chinese stocks is quite simple. Chinese stocks were expensive compared to other equity markets.
I used the CAPE ratios (also known as Shiller PE10, where the price-to- earnings ratio is based on average inflation-adjusted earnings from the previous 10 years) as at the end of September, in a report (Schroders Equity Lens Q4 2021) published by Schroders and adjusted by them by the changes in various country and regional indexes to estimate the CAPE ratios as at the end of December last year.
The MSCI China Index traded at a CAPE ratio of about 23 at the end of December, while the CAPE ratio of the MSCI All-Country World ex US Index stood at about 17. In comparison using the same methodology, The CAPE ratios of the MSCI Europe ex UK and MSCI Japan indexes were about 21, while, according to Professor Robert Shiller, the S&P500’s CAPE ratio was about 34.
The sell-off that started in February deepened as the ruling Communist Party tightened its grip over business, going after the private sector industry by industry and specifically the technology sector. Furthermore, Evergrande, China’s biggest property developer is in deep financial trouble. China’s manufacturing sector also buckled under power-supply issues that led to disruptions to production schedules.
Mr Market is known to take markets to extreme levels, sucking in investors at the top and spitting them out at the bottom.
The big question is how much of the bad news is priced in in Chinese equities, as represented by the MSCI China Index. I use three indicators of value, namely CAPE, price-to-book and one-year forward price-to-earnings ratios. I have estimated the current CAPE ratios by adjusting the values as per Schroders Equity Lens Q4 2021, with market movements since end-September. In the case of the US, I adjusted Robert Shiller’s most recent number for the S&P500 Index with the latest market-levels.
For price-to-book and one-year forward price-to-earnings ratios, I used the numbers published in the latest MSCI fact sheets, adjusted for up-to-date index-levels.
My analysis points to a linear relationship between CAPE and forward PE ratios across regions and major economic regions. China stands out like a sore thumb, indicating that the MSCI China Index is undervalued by about 13 percent relative to other countries and major economic regions.
China’s forward PE ratio of 12.5 matches the emerging market universe, as measured by the MSCI Emerging Market Index. Chinese stocks are however about 10 percent cheaper based on a price-to-book valuation.
The MSCI China Index experienced similar drawdowns over the past seven years. From April 2015 to February 2016, the index contracted by about 40 percent in terms of the US dollar and from January 2018 to October 2018, the loss was 30 percent. In both instances the bear markets lasted 10 months. The current bear market started in February and is also 10-months old.
The bull market ensuing in the 2015/2016 bear market, lasted for 22 months and saw the MSCI China double in value. The bull market from October 2018 to February lasted 26 months, with the index ending 55 percent higher.
The actions taken by the ruling Communist Party during this year in fact brought more certainty for corporates doing business in and with China. I suspect that the next move will be a clampdown on Chinese retail investors investing offshore.
Studies have shown that new traders are inexperienced and are easily caught up in a buying frenzy with borrowed money. Inward investing will most probably be encouraged.
Short-sellers beware! Beijing is prowling. We are about to enter 2022 with China continuing to ease its monetary policy, while the West is already mulling to do the opposite. The losers in 2021 are most likely to be the winners next year and the year after. Country rotation will be the name of the game in emerging markets in 2022. I am also of the opinion that the Chinese market offers lower downside risk than other emerging markets such as India and Taiwan, as well as most developed nations.
Yes, China, and especially the MSCI China Index is my pick of the year for 2022. Next year is the year of the Tiger in China.
May God bless you all during the festive season.
Ryk de Klerk is analyst-at-large. Contact [email protected] His views expressed above are his own. You should consult your broker and/or investment adviser for advice. Past performance is no guarantee of future results.
*The views expressed here are not necessarily those of IOL or of title sites.
BUSINESS REPORT ONLINE