First-quarter 2015 results are in the books for global markets and the U.S. finds itself in an unusual and unenviable position — our stock market is no longer leading the pack in performance — in fact we’re not even in the hunt.
Investors have grown accustomed to domestic stocks consistently outperforming other markets in recent years. In fact, U.S. stocks have dominated the performance derby for several years now as other major developed markets (Europe, Japan) and emerging markets (China, Brazil) have struggled.
But surveying my list of 75 single-country stock ETFs, I see a dramatic reversal in performance so far this year. While domestic equity ETFs haven’t fallen from first to worst, they did lag the rest of the world during the first quarter, and by a very wide margin.
|So far this year, China-tracking ETFs have outshined U.S. stocks.|
The top performing ETF over the first three months of 2015 was the Market Vectors China ETF (PEK), up 18.3 percent, and a half-dozen other China-tracking ETFs made it into the top-20 in performance.
The second best performing ETF was WisdomTree Europe Hedged ETF (HEDJ), an innovative ETF that allows U.S. investors to profit from both rising share prices in Europe, and from the falling value of the euro currency.
Like China, several European ETFs are also at the top of the performance list, including Denmark (EDEN), Germany (EWG), and Italy (EWI). In fact, all of the best-performing ETFs last quarter were either Asian or European.
By contrast, the SPDR S&P 500 ETF (SPY) was up just 0.9 percent last quarter.
Do you see a theme here? I do: Monetary stimulus!
The Federal Reserve tapered its quantitative easing (QE) stimulus last year, and is considering raising interest rates.
Meanwhile, central banks in Asia and Europe are cutting interest rates and launching new QE stimulus.
Last month, the European Central Bank (ECB) decided to borrow a page from the Fed’s quantitative-easing playbook with a massive $1.3 trillion stimulus program of its own.
Of course, the Fed perfected this play with multiple rounds of QE since the 2008 financial crisis. The result: A 200 percent-plus gain in the S&P 500 since then.
ECB chief Mario Draghi observed this result, and has lobbied for Euro-style QE for months now. The result: European stocks have likewise rallied sharply in anticipation of the ECB’s monetary stimulus.
That’s what makes China look very compelling as an investment right now.
China’s fast-paced economic growth has slowed in recent years, but with GDP growth of 7 percent, China is still the envy of most global economies. But the authorities in Beijing are concerned about slowing growth and have taken steps to counteract it.
In recent months, China has cut interest rates and eased lending requirements. Beijing has also opened up its domestic financial markets and introduced reforms including deposit insurance.
China’s domestic investors have responded, with Shanghai Stock Exchange trading volume soaring as investors opened a record number of brokerage accounts. The Shanghai Composite Index has surged 18 percent year to date, to a seven-year high as a result.
But this rally may just be getting started.
Just this week the governor of the People’s Bank of China (PBOC), admitted authorities in Beijing are worried about deflation saying: “China can have room to act,” both with interest rates and “quantitative” measures.
This is a clear nod toward a China-style QE program, and there’s little doubt after these “official” remarks that more monetary policy easing is on the way from Beijing.
Stocks are already responding, with Chinese stocks listed in Hong Kong posting the biggest gain this year on the news. In fact, Hong Kong is the best place to look for bargain stocks in China.
Chinese stocks listed on the mainland Shanghai Index typically trade at a premium to the same shares listed in Hong Kong. That’s because stock trading in Shanghai is dominated by domestic retail investors who, up until very recently, had no other choice, because access to Hong Kong was restricted.
As a result, Shanghai listed shares trade at a 36 percent premium above the equivalent stocks in Hong Kong; the biggest gap since 2011!
These are the exact same stocks including: Citic Securities, China Railway Group, Tsingtao Brewery, Petrochina and many more; the blue-chips of China, but the shares are available at much cheaper prices in Hong Kong than in Shanghai.
In fact, the Shanghai Composite Index carries a price-earnings ratio (P/E) of 18.7, not much different from the S&P 500 (P/E = 18.3).
But the China Enterprises Index of mainland Chinese stocks listed in Hong Kong trades at a steep discount, with a P/E of just 8.9 times earnings! And with China’s ongoing financial market reforms, this valuation gap is bound to close. In fact, late last year Beijing began linking stock trading in Shanghai with Hong Kong.
One ETF that is already profiting from this situation is the iShares China Large-Cap ETF (FXI). The fund tracks 50 of China’s largest blue-chip stocks trading in Hong Kong. Many of these same stocks trade in Shanghai too, but at much higher prices.
FXI gained 6.7 in the first-quarter alone, but is perfectly positioned for more upside from here as China increases its monetary stimulus and smart investors take advantage of bargain-priced stocks in Hong Kong.