Why China Stocks Are Buzzing Again (And Still a Total Bargain)
Lately, it seems like every investor I talk to has China on the brain. There's a real sense of FOMO (fear of missing out) as Chinese stocks have rallied hard off their lows.
The speed and magnitude of the rebound have left many scratching their heads, wondering if they need to reassess their views on the world's second-largest economy.
As someone who's been pounding the table on Chinese equities for nearly two years, watching this sudden rush of enthusiasm is both vindicating and slightly amusing.
It's amazing how quickly sentiment can shift from "China is uninvestable" to "Wait, should I be buying Alibaba?" – all without any fundamental changes overnight. But that's the power of narratives in the market, and those who can see through the noise often find opportunities others miss.
The numbers speak for themselves. The FXI and KWEB, two major China-focused ETFs, are up about 60% and 50% respectively, with tech giants Alibaba and Tencent leading the charge.
These aren't rounding errors – they're portfolio-changing returns that many investors missed simply because they couldn't break free from the prevailing bearish consensus.
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While some argue that the best gains are behind us, I believe this rally has staying power, underpinned by seismic shifts in policy, technology, and compelling valuations.
First and foremost, China has aggressively pivoted towards a pro-growth, pro-innovation agenda. Gone are the days of heavy-handed crackdowns on the tech sector. In their place, we're seeing a flood of stimulus measures, an easing of regulatory scrutiny, and a wholehearted embrace of emerging technologies like artificial intelligence.
Just last month, President Xi Jinping convened a rare meeting with China's top tech executives, urging them to "show their talent" and help the country achieve self-reliance in science and technology. This high-level endorsement is a stark contrast to the "common prosperity" rhetoric that spooked markets just a year ago.
This pivot isn't just short-term noise, but a strategic realignment that should provide a sustained tailwind for Chinese companies.
Secondly, the technological advancements coming out of China are simply astounding. While the U.S. has been the undisputed tech leader for decades, China is quickly closing the gap.
Companies like Alibaba and Tencent are at the forefront of this charge, leveraging their massive data troves and AI capabilities to drive innovation in everything from e-commerce to gaming to cloud computing.
In the AI arms race, China is proving to be a formidable contender. The country already leads the world in AI patent filings and is expected to account for 50% of global AI spending by 2030. Chinese tech giants are pouring billions into R&D, attracting top talent, and commercializing cutting-edge applications at breakneck speed.
But the company I'm most excited about right now?
Baidu. Yes, the stock has been a laggard compared to its tech peers, but I believe that's creating a compelling opportunity. Baidu's search business remains highly profitable and cash-generative, but it's the company's investments in AI that really have me intrigued.
Case in point: Baidu just released its ERNIE 4.5/X1 model, a state-of-the-art multimodal AI system that's showing remarkable capabilities in natural language processing, reasoning, and generation. ERNIE 4.5 is outperforming leading models like GPT-4.0/4.5 across a range of benchmarks, and Baidu is offering this technology at a fraction of the cost of comparable systems.
As ERNIE 4.5/ERNIE X1 and Baidu's other AI initiatives gain traction, I believe we could see a step-change in the company's earnings power and growth potential. Yet, the market seems to be largely ignoring this opportunity, with Baidu trading at a significant discount to its intrinsic value.
That's why, despite Alibaba and Tencent being larger positions, I think Baidu offers the most upside from current levels. Don't get me wrong, Alibaba and Tencent are phenomenal businesses, and I'm not selling a share. But at a 10x P/E and a 30% discount to NAV, Baidu is simply too cheap to ignore.
This brings me to valuations more broadly. Despite the recent rally, Chinese equities remain deeply discounted relative to their U.S. counterparts.
The MSCI China A ETF (CNYA) trades at just 16.3x LTM P/E, a stark contrast to the S&P 500’s (SPY) rich 27x multiple. This spread seems increasingly unjustifiable given China's superior growth prospects and technological momentum.
Digging deeper, the valuation disparities become even more glaring. The China Large-Cap ETF (FXI), a bellwether index of China's largest listed companies, trades at a paltry 12.4x LTM P/E. Compare that to the Nasdaq 100 (QQQ) at 35.9x.
Now, I know what you're thinking. "But what about the risks? The geopolitical tensions, the property market woes, the demographic challenges?"
Valid concerns, to be sure. But here's the thing - these risks are well-known and largely priced in at current levels. Meanwhile, the potential upside from China's economic rebalancing, consumption upgrade, and technological leapfrogging is being vastly underappreciated by the market.
Moreover, U.S. equities are looking increasingly frothy and vulnerable. Valuations are stretched by almost any measure, economic growth is slowing, and the Fed is backed into a corner (kind of). In contrast, China has ample policy ammunition, a stabilizing economy, and a burgeoning middle class eager to spend.
From a portfolio construction standpoint, this setup is a no-brainer.
U.S. investors are heavily overweight domestic equities and woefully underexposed to China. A modest reallocation could provide valuable diversification benefits and tap into a powerful secular growth story.
So, what's my approach? I'm sticking with my long-term holdings in Alibaba and Tencent, which I believe still have significant runway for growth. But I'm also looking to increase my exposure to Baidu. The market may be overlooking Baidu's AI potential right now, but I don't think that will last forever.
The FOMO around Chinese stocks is real, and in my opinion, it's justified. China is in the midst of a tech renaissance, and companies like Alibaba, Tencent, and Baidu are at the vanguard of this transformation. While the easy gains may be behind us, I believe the long-term bull case for Chinese equities is just beginning to unfold.
As always, these are just my perspectives based on my analysis and investment approach. Every investor needs to evaluate the opportunities and risks through their own lens. But if you're looking to participate in the future of technology, I believe you can't afford to ignore China.