A lot has gone wrong for Chinese stocks lately with a softer economy and trade war uncertainty weighing on investor confidence. However, for value-oriented investors that can mean that the conditions are becoming right for buying as cheaper valuations help improve the risk vs. return balance.
The chart of the week comes from a report on Chinese A shares which, aside from the valuations picture, also discussed the earnings outlook, remaining risks, and the policy backdrop.
The chart shows valuations for Chinese A shares (i.e. domestic/onshore listed), and the key point is that even excluding or including financials, valuations are starting to look cheap again.
Specifically the chart shows the trailing 12-month PE ratio for the Thomson Reuters Datastream total market index, with the PE shown for both the headline index and excluding financial stocks. I also show the long-term average for China A shares ex-financials to illustrate how the valuation metric is now trading below long-term average, which is a good proxy for calling something “undervalued”, particularly when there is clear mean reversion across time.
In our research process, we use valuations as an anchor or starting point (before bringing in other factors such as earnings, economic indicators, monetary policy, sentiment, and technicals). we find that as time frames increase and as valuation readings reach further into extremes, you can have progressively more confidence in the signal (bullish or bearish) that valuation presents.