China Trade Offer Could Drive Chinese Stocks to Outperform

China Trade Offer Could Drive Chinese Stocks to Outperform
iStock.com/bong hyunjung

Trade Offer From China Could End Stalemate and Drive Stocks Higher

We finally received some encouraging news on January 18, when news surfaced that China had put together a trade package aimed to please President Donald Trump and eliminate the massive trade imbalance.

At first glance, the proposed deal would see China accelerate its buying of American goods over a six-year timeframe with a combined value of over $1.0 trillion. The framework suggests the trade balance will plummet to even by 2024.

The stock market got excited on the news—but before you jump in, remember that it is only a proposal with no details or guarantees it will work or even be accepted by the White House. The thing to remember is that the trade war is not merely about the trade imbalance; it is centered on the theft of intellectual property and restrictions to entry.

But if President Trump accepts the deal (and ignores the China hawks in the White House), the resolution could end up being a major win for him (and we know how much he likes to win).

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The aftermath would be a boost to global stock markets, especially emerging markets and Chinese stocks that have underperformed over the last few years.

I have not generally discussed Chinese stocks, with the exception of Alibaba Group Holding Ltd (NYSE:BABA), one of my top Internet stocks.

If we assume a deal will be made, there are other and more lower-risk ways of playing the expected bounce in Chinese stocks.

Play Large-Cap Chinese Stocks Via the FXI ETF

An exchange traded fund (ETF) holding the top Chinese large-cap stocks is the iShares China Large-Cap ETF (NYSEARCA:FXI).

The FXI is heavily weighted in Financial Services (46.68%), followed by Communication Services (10.74%) and Technology (10.55%). (Source: “iShares Trust – iShares China Large-Cap ETF (FXI),” Yahoo! Finance, last accessed January 21, 2019.)

Over the past three months, FXI stock has outperformed the S&P 500 with a 4.79% gain versus a 2.55% decline in the index.

Chart courtesy of StockCharts.com

Or Play the Emerging Markets

But if investors want less concentration on Chinese stocks and would rather a play on the emerging markets including China, they could play via the iShares MSCI Emerging Markets ETF (NYSE:EEM).

The widely traded EEM is based on the extremely diversified MSCI Emerging Markets Index—over 1,100 mid- to large-cap stocks in 24 emerging markets.

Financial Services (24.70%) and Technology (23.69%) are the top two sectors. (Source: “iShares MSCI Emerging Markets ETF (EEM),” Yahoo! Finance, last accessed January 21, 2019.)

The country breakdown is broad but China is still the top holdings with a 30.70% representation.

EEM Regional Allocation 

  • China: 30.70%
  • South Korea: 13.55%
  • Taiwan: 10.76%
  • India: 8.72%
  • Brazil: 7.92%
  • Other: 28.35%

(Source: “iShares MSCI Emerging Markets ETF Exposure Breakdowns,” iShares, last accessed January 21, 2019.)

The EEM ETF has also outperformed the S&P 500 over the last three months, advancing 4.74%.

Analyst Take

We will likely know soon if the olive branch offered by China will be accepted. If no deal results, the bets on the FXI and EEM are off.

Comparative Valuation

  FXI EEM S&P 500
Price/Earnings 7.59 9.84 14.35
Price/Book 1.06 1.40 2.73
Price/Sales 1.09 1.15 2.03

(Source: Yahoo! Finance, last accessed January 21, 2019.)

If a deal is consummated, the attractive relative valuations of the FXI and EEM versus the S&P 500 could see an outperformance.