Chinese equities can offer 15% upside this year


January 2019 has brought some relief for equity investors after having witnessed a turbulent end to 2018. 

Investor sentiment remains poor as there is no shortage of uncertainties, but value investors should consider Chinese equities, particularly the mainland A-shares, which are priced at valuations one can’t ignore.

Chinese mainland equities are currently trading near the -2 standard deviation (-2SD) level. If history is any guide, this level serves as a good buy indicator.

The last time Chinese equities fell to this level was when the global meltdown occurred back in January 2016.

Investors have viewed countless portraits of US President Donald Trump and Chinese President Xi Jinping hanging against a wall of trade policies, while expecting US Federal Reserve chairman Jerome Powell to put up an accommodative monetary frame.

Earnings estimates of Chinese equities have bottomed by the end of 2016, and were revised upwards throughout 2017 and into early 2018, but as the trade tension between the world’s two biggest economies escalated, consensus has been pricing in the effect of trade tariffs on earnings by revising earnings estimates downwards.

Should there be any positive developments on the global trade fronts, investors can expect a reversal in the earnings revision trend.

Any constructive development on the global trade front could help improve investors’ confidence.

If the majority of the market participants are not positioned for a trade resolution, this could be a big positive for risk assets like the Chinese equities.

As of Jan 16, 2019, the price earnings (PE) ratio of the CSI 300 Index stood at 8.2 times, which is about 8% from the -1SD level, and 19% from its five-year average.

To investors who are looking to deploy their capital, we think now could be good time to start buying.

Chinese A-shares are generally more volatile in nature compared to the other Asian equity markets.

Given that, we recommend investors to allocate not more than 20% of their equity budget towards this segment.