China’s NASDAQ at record low valuation
China’s ChiNext, the NASDAQ-style board of the Shenzhen Stock Exchange, has kicked off the year of the Pig in style, rallying 11% in February and giving some potential early indications that investor risk appetite is returning in China. Approximately 10% of our current Champions Universe is listed on the ChiNext and our companies comprise almost 15% of the index, so we pay particular attention to its idiosyncrasies. The ChiNext’s aim is to attract innovative, fast growing, high-tech firms but it has been languishing at historic record low valuations and a breakout by the index may be seen as confirmation of the sustainability of the broader market rally.
In the near decade since its launch the index has seen some classic boom and bust cycles. There is a high level of trading activity in China, with estimates of up to 150 million day traders and a stock market driven by turnover from private investors, but this is the first significant move to “risk on” equities that we have seen over the past 12 months.
We have seen a series of rule changes from China’s securities regulator which have contributed to spurring 2019’s bullish mood and this has certainly contributed to investors shift to riskier stocks. Following the appointment of Yi Huiman as its new chairman in January, the China Securities Regulatory Commission said it will scrap an automatic margin call threshold, allow a broader array of collateral to be used for certain loans, lower capital requirements for riskier assets and broaden the scope for foreign investors.
There are further signs in February that investors are shifting more into privately-owned stocks in lieu of more defensive state-backed entities and that’s a reversal of what we had been seeing up to January. We see higher demand among foreign investors in A-Shares and as qualified foreign investors may soon be able buy stocks trading over-the-counter, as well as financial futures, commodity futures, and options, this should further stoke demand for mainland assets. In addition, MSCI Inc. will this month say whether it plans to add more Chinese stocks to its benchmark, including Shenzhen small caps.
ChiNext stocks exhibit superior growth rates to their larger cap peers and inherently a greater level of volatility. Growth rates are multiples of the main Shanghai board and set to accelerate in 2019 (+35% revenue), but this growth premium comes with an additional level of risk. The benchmark remains 65% below its all time 2015 peak. In downturns the higher flying companies are normally first hit and we have seen a greater number of firms announcing profit warnings.
While this gives even more reason to be selective it does not detract from the potential group mentality and shifts in sentiment that you can see in China. The example of Yi Huiman’s appointment highlights this as it also triggered a rally in shares of companies whose names share the same Chinese character as Yi. For us continuing to avoid the hype and investing in profitable, growing businesses is our aim, and one we have managed to achieve to date. For now 2019’s rally is still someway from 2015’s over exuberance.
