The U.S. or China? When it comes to stock market valuation, the choice is clear.
Donald Trump has been good for U.S. equities. The S&P 500 is up around 13 percent since his election in November, as markets have rallied behind the president’s pledges to increase infrastructure spending, cut taxes and bring back manufacturing jobs.
But here’s the bad news: Sooner or later these promises will hit the bureaucratic realities and roadblocks of U.S. politics (as we’ve written before). And when that happens the “Trump Rally” in U.S. equities could go into reverse. That’s because ultimately (as far as markets are concerned) actions speak louder than words. And then it could be time for “mean reversion” to make a comeback.
But even if the president delivers on all his promises, a lot of that growth has already been priced into the market. American markets are already way up. According to the cyclically adjusted price-to-earnings (or CAPE) ratio, one of my favourite valuation measures, the U.S. is the third-most expensive developed market today after Denmark and Ireland. So U.S. shares are far from cheap right now.
In short, the steam may be about to run out of U.S. equities. But it’s full steam ahead in China.
The Chinese middle-class boom
As we’ve shown you before, China is experiencing massive growth right now.
Its middle class is expected to grow to over 550 million people by 2022. To put this in perspective, China’s middle class will be 1.7 times the entire population of the U.S.
And this middle class plans on spending – a lot. Chinese consumer spending is set to increase 55 percent between 2015 and 2020.
So it’s no surprise that Chinese companies that stand to benefit from this demographic and economic revolution are also booming.
The shares of Chinese companies listed on the Hong Kong Stock Exchange are up 10 percent since the New Year (Chinese shares listed in Hong Kong are known as H Shares… we wrote about them here).
But here’s the thing: Right now shares in Chinese companies are much cheaper than their U.S. counterparts.
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U.S. vs China – where is the value?
The MSCI China Index, which tracks the biggest Chinese stocks listed in Hong Kong and the U.S., is trading at around 12 times forward earnings… that’s much cheaper than the 18 times forward earnings for U.S. mid- and large-cap stocks. And the H shares market is one of the cheapest markets in the world, at a price-to-earnings (P/E) ratio of 8.
We’ve written before about how there are a lot of reasons to invest in Chinese shares. And lower valuations is just one of them.
How does valuation look on a stock-by-stock basis?
To show you how this trend looks on a stock-by-stock basis, we’ve compared three Chinese companies to their U.S. comparables.
(Just to be clear… we’re not recommending any of these stocks. To see the best Chinese opportunities we’ve found, you’ll need to subscribe to The Churchouse Letter.)
1. Amazon vs. Alibaba Group Holding Ltd
Online retail in China is undergoing extraordinary growth. In 2016, Chinese consumers spent US$17.8 billion in just 24 hours on Singles’ Day (similar to Black Friday in the U.S.) on Alibaba (New York Stock Exchange; ticker: BABA) – the world’s largest retailer and China’s answer to Amazon (Nasdaq Exchange; ticker: AMZN). That’s US$741 million per hour. To put that in perspective… that’s equivalent to the entire economic output of Cambodia spent online on one website in just 24 hours.
The shares of Alibaba have risen 19 percent over the last 12 months – compared to 10 percent for Amazon. And right now the shares of Alibaba are a lot cheaper than those of Amazon.
Alibaba’s P/E ratio is around half that of Amazon – at 41.9 compared to 81.8. And the earnings of the two companies are forecasted to grow at around the same average rate over the next few years, as this table shows.
What’s more, Internet penetration in China (at 52 percent) lags far behind the U.S. (at 89 percent). So as China continues to grow… Internet use and online retail are set to grow too. And that’s good news for investors in Alibaba.
2. Johnson & Johnson vs. China Resources Pharmaceuticals Group Ltd
If there’s one thing that China’s booming middle class will spend their new disposable income on… it’s taking care of their health.
China’s population is growing older, too… right now about 16 percent of people in China are over 60. But in 2050, people over the age of 65 will account for 27 percent of China’s population. That means more cases of age-related diseases… and a rising demand for pharmaceuticals.
China Pharmaceuticals (Hong Kong Stock Exchange; ticker: 3320), China’s second-largest drug maker, is well-positioned to benefit. It manufactures Western pharmaceuticals, traditional Chinese medicines and health supplements. Its shares are up 9 percent over the last 12 months… and with a P/E ratio of 17.8 its stock is priced in the same ballpark as Johnson & Johnson (New York Stock Exchange; ticker: JNJ).
But China Pharmaceuticals is a lot smaller. Its market cap is just around US$8 billion… compared to Johnson & Johnson’s US$356 billion market cap.
And look at the earnings growth… China Pharmaceuticals is set to grow more than twice as much as Johnson & Johnson in both 2017 and 2018, as the table below shows.
3. AT&T vs. China Mobile Ltd
The future is looking bright for China Mobile (New York Stock Exchange; ticker: CHL). The world’s largest mobile phone operator has 850 million subscribers (and counting)… and those customers are fast upgrading from cheaper 3G to pricier 4G data plans.
China Mobile 4G subscribers grew 59 percent in 2016 alone to reach 535 million – that’s more than the entire population of the U.S. And in 2020, China Mobile plans to launch high-speed 5G services … and its long-term prospects look good.
China Mobile shares are priced similar to U.S. mobile giant AT&T (New York Stock Exchange; ticker: T) on a P/E basis. But China Mobile is set to grow three times as much as AT&T in 2017, and more than twice as much in 2018, as this table shows.
Of course, these are just three comparisons. There are lots of reasons for stocks in similar markets to be valued differently. And these Chinese stocks may be valued less for good reason.
But here’s the big picture: While China’s middle-class boom is going to run and run… the “Trump Rally” looks to be on its last legs. So there’s never been a better time to invest in some “made in China” stocks and profit from this once-in-a-generation bull market.