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August 7, 2013

Idea Of The Week: Is China Now Oversold?

by Steven Carroll.

It’s accepted wisdom right now that the Chinese economic tiger, while still potent, isn’t roaring quite so loudly. In Q2 of 2013, China’s annual GDP growth slowed to 7.5 percent, the ninth quarter in the last 10 that expansion has weakened. Should investors stay away? Thomson Reuters StarMine research indicates a couple of the “slow growth” Asian countries, including China, may be worth a closer look.

When one looks at country valuations across Asia, the chart below looks as expected. The countries of North Asia, those most exposed to the slowdown in Chinese GDP growth, are clearly less expensive as Chinese growth has moderated. This will trickle down to slower company earnings as the boom turns to a more sedate, yet still impressive economic expansion.

Selected Asian countries by Aggregate P/E Ratio
Source: StarMine

The ASEAN nations occupy much of the right side of the graphic – those with higher aggregate P/E ratios. This fits with the accepted view that we’re seeing fast growth in SE Asia and slower growth in China, Hong Kong and India. Yet, if we introduce a second graphic showing the P/E ratio for the country alongside the forecast EPS growth rate for next year, things become more interesting.

PE Ratio and FY2 growth for Selected Asian Countries

Clearly other factors are at play. Retail fund flows out of ETFs highlight that emerging markets are out of favor and institutional positioning is equally bearish – yet Asia’s two BRICs seem to offer compelling EPS growth far above the regional averages, and at below average P/Es.

Thinking back to the hype about China, India or indeed all the BRIC countries three years ago, the basic theme was that these large economies with huge populations would represent much of the world’s GDP growth over the medium term. In the background, the recession-ridden West would continue to de-leverage. While on a comparative basis the U.S. is now growing at a modest pace, and the risk of an EU catastrophe has receded for the time being – the fundamental premise is unaltered.

There are many academic studies highlighting the propensity to chase performance – yet now we have the only two countries of the world with populations over 1 billion on sale for single digit P/Es with double digit growth. Both countries have much to do. China needs to rebalance away from its export- and property development-led model and India needs to encourage the private sector through improving infrastructure and reducing its legendary red tape. Market exuberance and expectations were clearly unrealistically bullish three years ago but it looks like the pendulum has now swung too far the other way.

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