I’ve been asked a lot recently if it is now time to start investing in Chinese companies, given the country’s improved relations with the United States. Bargain hunters may also appreciate the dip Chinese stocks have taken after the emergence of coronavirus, the latest bug to complicate everyone’s air travel experience.
In the big picture, China is also taking major steps towards a more Western economy – which is certainly long-term bullish for Chinese stocks. And there have been some major developments toward that goal in just the last few weeks:
On January 1, the People’s Bank of China announced that it will loosen requirements for bank reserves, from 13% of funds to 12.5%. In other words, Chinese banks will be more liquid; they’ll have more cash available to lend, including for small businesses there. This will be more like the United States, which requires big banks to hold 10% in reserves, while the European Central Bank requires just 1%!
This is China’s eighth reserve-ratio cut in two years, and it’ll also help banks’ profitability.
That’s especially important now because of the other big move China just made: to cut interest rates.
Until now, China’s benchmark lending rate was 4.35%, and had been since October 2015. All the while, other central banks had kept their rates ultra-low – even negative, in some cases!
Now, finally, China bumped that down to 4.15% on January 1. While lower rates can cut into bank profits, it does tend to increase borrowing (since the loans cost less). More loans mean more investments…which is a nice “shot in the arm” for the economy overall.
It’s also helpful to individual households. Which brings me to the other important fact you need to know about China:
China Is Now a Consumer Economy
If you’re like me, when you think of China’s business model, you think of manufacturing – all those “Made in China” labels.
But, remember, China is huge, with 1.4 billion people, and a GDP of over $14 trillion annually. (That’s more than Germany, the UK and India combined!)
So, as huge as Chinese manufacturing is, it’s actually only 26.5% of its economy. Meanwhile, roughly half is from services.
As China’s economy has grown, so has the standard of living there. Along with that, Western luxuries are in high demand, which was one point in our favor during the U.S.-China trade negotiations.
After nearly a year of back-and-forth, President Trump and Chinese Vice Premier Liu He signed the Phase One trade deal on Wednesday, January 15. China has agreed to buy an additional $200 billion worth of American goods in the next two years. Agricultural goods, including soybeans and pork, will account for $12.5 billion in the first year and $19.5 billion in the second year. In aggregate, U.S. exports to China could soar to more than $260 billion this year and about $310 billion in 2021.
On the flip side, the U.S. agreed to slash tariffs on Chinese goods. The 15% tariff on $120 billion worth of Chinese goods will be reduced to 7.5%. The 25% tariff on $250 billion worth of Chinese goods will remain in place, but it will be discussed in the Phase Two trade deal negotiations, which are already underway.
How to Invest in China
Many Chinese companies were hurt by the U.S.-imposed tariffs, as their products were made more expensive. So, yes, these companies, especially Chinese manufacturers, should see their businesses improve this year.
From an investment perspective, though, there’s one big thing to keep in mind: Lots of Chinese companies don’t have strong enough fundamentals to rate a “buy” in my stock-picking system.
In other words, rather than dive headfirst into the Chinese stock market, you’ll want to be very choosy.
One I like now is New Oriental Education & Technology Group (EDU). EDU’s biggest claim to fame is as one of two Chinese companies to “crack” the SAT and help its students attain high scores on the college admissions materials.
Just yesterday, the company posted blowout earnings for its fiscal second-quarter results. Earnings per ADS surged 147% year-over-year to $0.36, up from $0.14 per ADS in the same quarter a year ago. Consensus was for $0.21 per share, so EDU posted a stunning 71.4% earnings surprise.
I added the stock to my Accelerated Profits Buy List back in the fall, and in the three months since my recommendation, EDU is up 15%.
I’m also excited about a Chinese semiconductor company that we added to the list in November. In its fourth-quarter results, released late last week, the company reported strong earnings and sales growth and is now sitting just a few dollars below its 52-week high.
In contrast to the riskier plays out of China, both these stocks are an A-rated “Strong Buy” in my Portfolio Grader. That includes top marks for their Quantitative Grade – my proprietary measure of institutional buying pressure.
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