China is under the cosh just now. The prospect of inflation and rising bond yields has galvanised the risk-off trade. Value stocks have lured investors away from their growth counterparts. And, as if this negative sentiment on the macro were not enough, investors have fretted further on Beijing’s anti-trust campaign against some of the bigger, more dominant players in the market (Ant Financial, Meituan, Tencent).
As you know, the valuation metric at the heart of our process is the PEG ratio. PEGs of 1x or better have us on the buy tack. Like most composite statistics, our “average PEG” ratio is subject to exceptions and some caveats. Of course, the spike last year was a result of Covid as earnings growth (the denominator in the PEG ratio) was impacted. Conversely, the plunge in the PEG this year has been aided and abetted by a significant jump in that growth from a low 2020 base. But at least the chart below of our historic figures gives you a fairly accurate valuation range since inception.
The last time our PEG headed into this sort of territory was Q4 2018. Rather than inflation and regulation, back then it was the prospect of a looming trade war which undermined sentiment towards China. We were more sanguine: given that the days that China’s dependence on trade were long over and that Chinese consumption (our own exclusive focus) was a domestically driven phenomenon, we remained bullish about the prospects of our names (see links to China through the US Looking Glass, China through the US Looking Glass II, China through the US Looking Glass III and China through the US Looking Glass IV). This view began to gain traction as 2019 progressed. Rather than being dead and buried, the Chinese consumer was very much alive and kicking. A sharp recovery in the valuation of our stocks followed in 2019.
The punchy results, which we have seen so far from several of our holdings (Li Ning, East Money, JD.com, SEA, Banco Inter, Varun Beverages) suggests that our growth forecasts look perfectly reasonable, notwithstanding the macro concerns.
Looking back and making comparisons can be a dangerous game. If inflation were to become a systemic feature of the global economy, then it would be reasonable to expect a longer-term impact on valuations. However, those nice people at the Fed have assured us that inflation will have “only transitory effects on underlying inflation”. And it is worth noting that that the current fixation with inflation is a US (rather than a Chinese) phenomenon. In China inflationary signs appear far more subdued.
So: Risk or Opportunity?? Given the valuations we are seeing just now, investors should be considering the latter. We shall be writing further about this shortly.
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