With the U.S. market full of nosebleed valuations – think Netflix (NFLX), Tesla (TSLA) and Facebook (FB) – stocks in China appear downright delectable.
As Nomura reports, “China remains Asia’s deepest-discounted market.” Shares trade hands for 8.6 times forward earnings versus their long-term average of 12 times. That’s a 28% discount.
Meanwhile, U.S. stocks trade for almost 16 times forward earnings.
Indeed, Chinese stocks appear (cue Robert Palmer) simply irresistible.
Looks can be deceiving, though, which is why I wouldn’t invest a single penny in China right now.
More Expensive Than Meets the Eye
On the surface, Chinese stocks seem cheap. But they’re not.
The average is being skewed by super cheap valuations for financial stocks, which carry a 40% weighting in the index calculations.
According to analysts at HSBC Holdings (HSBC), it turns out that if we exclude banks, Chinese stocks trade right in line with the long-term average.
Plus, if we strip out state-owned enterprises, the valuation picture completely flip-flops.
Privately owned enterprises are trading hands for about 25 times forward earnings – a 57% premium to U.S. stocks.
Clearly, Chinese stocks aren’t cheap. But that’s not the only reason why I wouldn’t buy them today…
Fundamentally Speaking
Beginning in February, I started warning you about weakening fundamental underpinnings in China. From slowing economic growth to a slumping currency to a budding credit crisis…
In a month’s time, things have only gotten notably worse.
While the latest GDP figures checked in at 7.7%, a consensus is forming for even lower growth. Anything below the stated goal of 7.5% would be the slowest rate in almost 25 years.
Mind you, these are only estimates. And reality might end up being better. But I wouldn’t bet on it. Not based on the latest economic data.
Take exports, for example, which represent a major engine of economic growth for China. They unexpectedly fell 18.1% in February, the steepest decline since the global financial crisis.
Meanwhile, key barometers of China’s economy are flashing warning signals, too…
China is the No. 1 consumer of copper and iron ore. And prices for both commodities are getting clobbered. Copper alone is down more than 12% on the year.
That’s doubly bad news. As Steve Scacalossi at TD Securities notes, “Copper and iron ore are heavily used in China as collateral on loans.” As prices weaken, so does the asset base that’s securing China’s runaway lending.
Speaking of which, China could be careening towards a “Lehman Moment” of its own, when a major default sparks dozens more and credit freezes up.
Consider: Last Friday, the country suffered its first-ever corporate bond default when solar company Chaori reneged on its obligations. The second one could be right around the corner, too, as bonds of Baoding Tianwei Baobian Electric Co. were suspended from trading on March 11.
Moreover, lending in China’s shadow banking system in February “evaporated to almost nothing from $160 billion in January,” as the Telegraph’s Ambrose Evans-Pritchard put it.
Obviously, worsening credit conditions promise to hamper economic growth even more.
Jeffrey Gundlach, Founder of DoubleLine Capital, thinks China is “overdue for a significant setback, economically.”
Agreed. By all accounts, it could be materializing as we speak.
So much for that “soft landing” that so many pundits predicted, huh?
Bottom line: At some point, Chinese stocks will represent an undeniable contrarian buying opportunity. But that time is definitely not now, given the recent spate of negative developments, and the fact that the Shanghai Composite Index just traded below its key support at 2,000.
Or, more simply, look out below! And wait for the real bargains to materialize.
Ahead of the tape,
Louis Basenese
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Original Article: Frozen Credit Markets Foreshadow Next Lehman Fiasco
