Chinese Stocks and FXI

On February 19, 2023, in a Barchart article, “FXI and BABA – Geopolitical Tensions are a Warning Sign,” I wrote:

In my late November Barchart article, I wrote, “Risk-reward favors Chinese stocks and the FXI ETF at the current level, and value seekers like Charlie Munger believe they are “worth the risk.” The balloon incident and the state of U.S.-Chinese relations have increased the risk. 

FXI was at the $29.53 level on February 17, with BABA shares at $100.01. The Chinese stocks have underperformed the U.S. S&P 500 and NASDAQ since mid-February.

Steady in the S&P 500 and NASDAQ since February 17

On February 17, 2023, the S&P 500 closed at 4,079.09, and the NASDAQ composite settled at 11,787.27. On May 9, the leading stock market index was 1.1% higher at 4,125.24, and the tech-heavy NASDAQ at 12,195.21 moved 3.5% to the upside. 

After settling at $29.53 per share on February 17, the iShares China Large-Cap ETF(FXI) stood at $28.34, 4% lower, underperforming the two leading U.S. stock market indices.

FXI edged lower over the period for three reasons

The three factors weighing on Chinese stocks are:

• Investors have become skittish about Chinese companies as relations between Washington, DC, and Beijing deteriorated. 
• Chinese companies do not offer the same level of transparency as U.S. or European companies that trade in the global equities markets.
• While U.S., European, and companies operating in Democratic and capitalistic countries are private entities subject to regulation, Chinese companies are ultimately state-owned and run companies, reporting to the Chinese Communist Party.

The bifurcation of the world’s nuclear powers that began with President Xi’s handshake with Russian President Putin in February 2022 and the subsequent war in Ukraine significantly impacted investors’ appetite for Chinese stocks. 

BABA shares plunged

Alibaba Group (BABA) is China’s leading e-commerce company, with its ADR trading on the NYSE. BABA is China’s answer to Amazon (AMZN). On February 17, 2023, BABA shares were at the $100.01 level. 

The chart highlights the 18.4% plunge to $81.63 per share on May 5, 2023.

While BABA remains 40.5% above the October 2022 $58.01 low, the stock has declined 74.4% from the October 2020 $319.32 record peak.

Munger still owned BABA – He Admits it was a Mistake

In the latest 13-F filing for Q1 2023, Charlie Munger’s Daily Journal Corporation maintained its 300,000-share long position in BABA. However, Mr. Munger, Warren Buffett’s sidekick, admits his investment in the Chinese e-commerce company has been a disaster. In February 2023, he called his purchase of BABA shares “one of the worst mistakes I ever made. I never stopped to think [Alibaba] was still a retailer. It’s going to be a competitive business.” 

Meanwhile, the China-U.S. trade and geopolitical dynamic have likely weighed on the company’s ADR. While his BABA shares were still 19% of Daily Journal Corp’s holdings at the end of Q1 2023, Mr. Munger has sold shares over the past quarters, cutting his long position as BABA shares have turned in a miserable performance. 

The current environment does not support Chinese stocks

The U.S. stock market remains shaky after short-term interest rates rose by 5% since March 2022. Moreover, the debt ceiling issue, geopolitical turmoil, nagging inflation, recent bank failures, and increasing recession potential make equity markets challenging. Companies with cash hoards and significant earnings will likely weather the financial storm. However, emerging companies promising future profits while requiring financing in the current interest rate environment will struggle. Therefore, identifying value in the stock market has become an issue for investors.

While Chinese stocks offer value on paper, and the Chinese economy could be eclipsing the U.S. over the coming years, the geopolitical tensions between Washington and Beijing remain a clear and present danger that could lead to trade barriers and even delistings of many of China’s leading companies trading on the U.S. and other foreign exchanges. 

At $28.34 on May 9, the FXI ETF’s price-to-earnings ratio stood at 10.62. The SPY and QQQ’s P/E ratios were 17.86 and 22.70, respectively. The ETFs representing the S&P 500 and NASDAQ Composite were significantly higher than the FXI. However, the lower valuation comes with substantial risks that many investors are unwilling to take in the current environment. 

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