Simultaneously, a new wave of consumer and domestic-oriented companies has come to dominate China’s equities market. In particular, stocks of internet companies that cater to China’s burgeoning middle class, which grew from 5 million people in 2000 to 225 million in 2016, according to consulting firm McKinsey, have exploded. Social media giant Tencent, China’s version of Facebook; and e-commerce powerhouse Alibaba Group, China’s version of Amazon, are up 84.8 percent and 105.6 percent, respectively, year-to-date through Oct. 13. Those two stocks now account for almost 30 percent of the iShares MSCI China ETF (MCHI), which tracks the MSCI China Index.
“These internet companies have facilitated the roll-out of lots of other types of businesses in China — from gaming to payment systems, online money market funds and streaming entertainment,” says Mattock. “What investors are buying today at a stock level in China is a lot more diversified.”
There are three times as many companies, and the market capitalization has gone from $2 trillion in 2004 to $12 trillion.
“The companies driving the stock market earnings now are not the cyclical industrial companies of the past. So that means a lot better cycle in terms of earnings. I don’t think we’ll get the same uplift in corporate earnings next year as this year, but I still think we’ll see healthy profitability growth,” Mattock said.
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That said, the Matthews Asia manager is cautious in the short-term, but enthusiastic longer-term about Tencent and Alibaba. “Internet stocks are at fair value on a 12-month review,” he said. “But the growth drivers behind these companies are so diversified that on a three- to five-year view, there’s not much downside to them.” He added, “Seventy-five percent of all time spent on the Chinese internet is via a Tencent application.”
The scale of China’s internet potential is enormous, according to Mattock, who claims that “269 million people watched the NBA final last year in China via Tencent’s streaming service. In the U.S. it was 30 million.”
Valuations are better in sectors outside the big tech names. Chinese stocks in the MSCI China Index as a whole have a 2018 forward price/earnings ratio of 12.7. “If you take out technology from the mix, they’re at 8 times,” Harriss said. Tencent and Alibaba have forward price-to-earnings ratios of 36x and 41x, respectively, according to Morningstar. The S&P 500’s P/E ratio is 20.6.
