Don't focus too much on China, says JP Morgan AM

Chinese valuations are not yet in bubble territory, but investors should avoid confusing economic performance with stock-market returns, says emerging-markets head Richard Titherington.
Don't focus too much on China, says JP Morgan AM

Much has been written in recent months about whether Chinese stocks or property are overvalued, and a growing number of editorials and research papers seem to be coming out on the side of the bears.

The strategist for the investment arm of a large Asian state-owned institution recently told AsianInvestor that they believe the country is heading for a crash. There are too many potential problems in the Chinese economy and financial markets for that not to happen at some point, she argues. In which sector or part of the economy that crash takes place is less certain, says the strategist, but it is inevitable.

"We should only be in China with calculated risk and exit strategies based on the senario of a crash somehow, somewhere that will have a domino effect and impact investments in China," she adds. Now that Chinese prime minister Wen Jiabao has publicly said (in mid-March) that it will take the nation another 40 years to be a moderately developing country, it means those "who want to hitch their wagon to China's back" have to "deal with it". 

Of course, there are plenty of people who say prices in China have some way to run before they hit bubble territory. One is Richard Titherington, chief investment officer and head of emerging markets equity at JP Morgan Asset Management in London. He oversees the firm's global emerging-market funds, including emerging Europe, the Middle East and Africa, and Latin America.

"I don't think China valuations, either of equity or property, are bubble-like in general," he says. "There are always individual property projects or stocks that are overvalued of course. It might become a bubble, but is not there yet."

On average, Chinese price-to-earnings ratios are in the mid-teens, which he does not feel is excessive. Some stocks, such as China Mobile, have a P/E closer to 10x, and China P/Es range from 10x to 40x, he says.

"It's still a market where stock selection is extremely important," says Titherington. "When you look at previous bubbles, everything was overvalued, and that's not the case with China."

Asked what sort of levels would concern him, he said he would be concerned if P/E ratios were to significantly exceed earnings growth. "If you assume Chinese earnings growth is in the high teens or 20%," he says, "then if you're paying significantly above that, you're in dangerous territory."

Yet while Titherington plays down the 'China bubble' concerns, he does feel there is too much focus on the country to the exclusion of other emerging markets.

"I agree with the general consensus that emerging markets are rising in importance," he says. "But people often confuse economic performance with stock-market returns; they focus on GDP growth, when they should focus on earnings growth. Countries with the best economic stories are not necessarily the best places to invest."

For example, China's economic growth has been consistently higher than Brazil's, he says, yet Brazil's stock market has outperformed China's over most time frames, such as one, three, five or seven years. 

Titherington points out that it's been possible to make good returns from places that are not obviously attractive, citing Egypt as an example. Some companies in the country have seen triple-digit growth in the past 12 months -- it's attractive more on an individual basis than an overall index basis, he says. Even in countries that have done badly, like Argentina, you can find good companies.

"The surprising thing is that investors continue to focus on GDP and not on earnings per share," says Titherington. "Which is why so many say: 'Why look beyond China?'."

With regard to less obviously attractive markets in Asia, AsianInvestor asked him what he felt about Indonesia, which has been increasingly attracting attention and is moving ever closer to an investment-grade rating.

"Indonesia is very interesting," he says. "Our only concern is how popular it is with investors right now. I agree with the long-term idea that the country has done more than any other country to define its relationship with China in a way that will favour its own economic growth."

But Titherington believes it is "worrying" that everyone is thinking along similar lines.  "Whenever investors behave or think like a herd," he adds, "this can result in pro-cyclical behaviour." 

"It's a question of what the trend direction is and what price you're ultimately being asked to pay for the opportunity," he says. "If you're being compensated for the risk you're taking through the valuations then that's OK. Typically when people have overpaid and been over-optimistic about emerging markets, they have been disappointed."

Titherington says the "ultimate risk" is overvaluation, overpaying. "And that's the concern over China and India," he adds.