Returns from Chinese Stocks Likely to Underwhelm

June 6th, 2012 by

When it comes to market turbulence and uncertainty, these days the buzz all revolves around the dramatic events unfolding in Europe and, to a lesser extent, what is happening to the American economy. But anyone hoping to find some kind of refuge in the emerging markets – and particularly in China, the emerging economic and political superpower – may want to think twice.

As we reported late last month, StarMine models suggest that it’s still too early to embark on any bargain-hunting expeditions in Asia, where stock prices have underperformed most other regions of the world. In China alone, stock prices are down 16% from their March highs, but the value created by that selloff comes with big risks attached. Now, a new analysis of the most recent data suggests that the picture doesn’t appear likely to change any time soon. The “Predicted Surprise” – for earnings – the percentage difference between StarMine’s SmartEstimate, which puts more weight on recent forecasts and top-ranked analysts, and the mean estimate of all analysts – for emerging Asian markets earnings as a whole, currently stands at -1.6%. Among all markets in the region, China’s Predicted Surprise is -2%, second only to that of Sri Lanka, which comes in with a -2.8% Predicted Surprise.

Analysts appear to be overestimating earnings growth for companies in most parts of the Chinese market, but especially so when it comes to industrial, information technology, materials and above all, telecom services firms. The latter all are sending bearish signals, with a Predicted Surprise of more than -6%; any figure north of 2% or south of -2% is highly predictive of the direction of change in estimate revisions and earnings surprises. When the Predicted Surprise is off by that magnitude, the SmartEstimate tends to get the direction of earnings surprises correct more than 70% of the time.

China clearly appears to be in for a tough 12-month period. The reasons for this aren’t hard to spot: despite the best efforts by the country’s leaders, China remains an export-driven economy, heavily reliant on its ability to supply consumers in North America, Europe and other parts of the world with the latest fashion items and electronic gadgets. The problem is straightforward: the United States and Europe each account for 20% or so of China’s exports. European growth is already in the doldrums; to the extent the contagion spreads to the United States, China could see a precipitous drop in its export income.

That, in turn, spells trouble for China’s domestic market. If the country’s businesses earn less from their exports, they will have less available to spend, whether on salaries – which means Chinese workers will have less to spend on pricier imported goods – or even on raw materials. China’s overall producer price index has seen gains become losses since late 2011, as growth slows, and the slowdown in the overall Chinese economy already has taken a toll on the prices of most industrial commodities worldwide. The result is what many analysts have described as an end to a 10-year commodity supercycle, as crude oil prices now languish 24% below their highs of February and copper prices have slumped 17% since then.

China’s effort to transform its economy to be less reliant on global export markets has encountered some outsize challenges as growth has flatlined in its major markets. In the absence of rosier economic data than we are seeing right now, or the replacement of the current batch of negative Predicted Surprise data with some more upbeat views of what earnings will do, it may still be far too early to venture back into this corner of the world. Investors may do well looking elsewhere for growth.

  • Ernest

    What Utopia? -  They have their problems too.