C.J. Lawrence Weekly Market Comment – Favorable Risk-Reward Emerging in Leading Chinese Consumer Stocks

Trade and tariff concerns caused U.S. equity markets to stumble in early June and have dominated the business news flow since. But as investors turned their attention to 2Q18 earnings results, some fear subsided, and U.S. stock prices recovered. The S&P 500 Index price is up 3.1% since July 1. But the same cannot be said for the Chinese stock market. Since U.S. tariffs on $50 billion of Chinese imports were announced on June 14th, the Shanghai Composite Index is down 6% in local currency. It is now down 14% for the year. Since the tariff announcement, the Chinese yuan is down ~6% versus the U.S dollar making currency adjusted performance even worse.

The prospect of a protracted trade war with China appears to present more risk to China than to the U.S., but most experts agree that trade and tariff wars, regardless of protagonist, lead to casualties on all sides. A sell-off in Chinese shares is understandable given that country’s position as an export-lead economy, the recent release of some lackluster economic data, and a rising debt-to-GDP ratio. Chinese shares have also been caught in a downdraft of emerging market equity fund redemptions. Despite having the second largest economy in the world, China remains the most heavily weighted country in emerging market equity indices and funds. After a strong start to the year, the MSCI China Index is down 4.4% in the last three months, while the MSCI Emerging Markets Index is down 5.1% during the same period.

The sell-off in Chinese shares, including those listed on U.S. stock exchanges, may provide an attractive buying opportunity for investors with a longer-term view. Despite its challenges, China remains the worlds’ fastest growing economy, according to data provided by the World Bank, and its domestic consumer economy is being fueled by a growing middle class, which is expected to reach 780 million people, from a current level of 430 million, by the mid-2020s. Should trade and tariff wars persist, that growing consumer base will focus increasingly inward for goods and services. According to a report from Mizuho Securities, Chinese retail sales will reach $5.8 trillion in 2018, a level on par with the United States. Forrester Research suggests that Chinese consumer online spending will exceed $1 trillion in 2019, up from just $300 million five years ago. This massive growth in consumer buying power and demand is being met by leaders in e-commerce, digitization, logistics, cloud computing, and entertainment like Alibaba Inc. (BABA), Tencent Holdings (TCEHY), JD.com Inc. (JD), and Baidu Inc. (BIDU). On average, these companies are expected to grow revenues at a 30% pace in both 2018 and 2019. The risk-reward for large cap, U.S. listed, Chinese consumer and e-commerce related companies looks increasingly favorable.

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