Investors have cooled on China in the past week. Shares of the iShares MSCI China Large Cap ETF (FXI) are down about 5% from their recent highs.
The “reason” for the selling, if we are to believe the headlines, is that investors worry the People’s Bank of China is orchestrating another cash crunch to teach property speculators a lesson. Call it the risk of Chinese tapering, if you will, but it is not something I would spend a lot of time worrying about. The far more likely explanation is that, after rising by over 20% since July, Chinese stocks simply needed a breather.
I recommend you take advantage of this lull to accumulate shares of Chinese equities, whether it be via an ETF option like FXI or via purchases of your favorite individual Chinese stocks. The Chinese economy is showing signs of life again, and Chinese equities have been in a long, sideways correction for nearly four years (see chart).
After the long, multi-year correction, Chinese shares are now ridiculously cheap. By Financial Times estimates, they trade hands for 7 times earnings and yield 4.6% in dividends. Navigating the Chinese market is tricky, as some share classes are restricted to Chinese nationals. But even the liquid stocks available to international investors—such as those that comprise FXI—are incredibly cheap by world standards, trading at about 8 times earnings.
Could the recent surge in Chinese stock prices be yet another head fake? Of course. But the economic data suggest that the Chinese locomotive is starting to build up steam again. Manufacturing production just hit a 7-month high, and new orders and new export orders are showing signs of life. Estimates for GDP growth are coming in at 7.7% for the year, and Western firms are showing new interest in Chinese brands. American private equity firm KKR just announced it would be making a $550 million investment in Chinese white goods maker Qingdao Haier.
As I wrote last month, home prices in most Chinese cities continue to rise, and government corporate and personal income tax revenues have come in stronger than expected.
Does any of this mean that a Chinese bull market is guaranteed?
Of course not. But the conditions are certainly in place. Pricing is cheap and sentiment towards China is as bearish as I’ve ever seen after years of stock market disappointment. With Chinese data rolling in better than expected—and with the U.S. market starting to look a little on the expensive side—I expect investors to reevaluate China in the final months of 2013.
The last big bull market in Chinese shares saw FXI gain more than 300% between 2005 and 2007. I don’t necessarily expect a repeat of that performance over the next three years. But I do expect Chinese shares to outperform their American peers by a wide margin.
Sizemore Capital is long FXI.
Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE 8-part investing series that will not only show you which sectors will soar but also which stocks will deliver the highest returns. The series starts November 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.
This article first appeared on InvestorPlace.