Slowing Growth, Sliding Yuan Tempt Some to Buy Chinese Stocks

   By Nicole Hong 
 

For an increasing minority of foreign investors, now is the perfect time to scoop up Chinese stocks.

Chinese shares have dropped to their cheapest levels in three years as the world's second-largest economy posted growth of 7.6% in the second quarter, its slowest growth since early 2009. At the same time, the yuan is 1% lower against the dollar this year after it had appreciated 4.7% last year.

But instead of viewing the deterioration as a sign to get out of the battered Chinese market, the now discounted valuations are driving in more foreign investors. This month, foreign investors became net buyers of Chinese equities in consecutive weeks for the first time since February, with Chinese equity funds pulling in $98.22 million in the two weeks up to Aug. 22, according to fund tracker EPFR Global.

This buying, partly based on a belief that Chinese leaders will take action to stimulate the economy, could support the yuan from further depreciation.

"Monetary stimulus will provide some lift to valuations to China," said Rick Harper, head of fixed income and currencies at New York-based WisdomTree Investments, and one of those scooping up more Chinese stocks.

The $4.1 billion WisdomTree Emerging Market Equity Fund (DEM) more than tripled its percentage of Chinese stocks to 14% in June, during its annual rebalance. The portfolio had been underweight China for five years because it only includes stocks that are among the 30% cheapest in emerging markets.

Among its picks, the fund added heavily in Chinese bank stocks with dividend yields above 5%, including China Construction Bank Corp., which is now the fund's top holding.

To be sure, foreign investors remain net Chinese equity sellers on the year, with $670.67 million in outflows. These outflows have helped the Shanghai Composite Index fall 21% over the past 12 months and lose 5.7% this year, hitting a fresh three-year low on Monday.

But recently, large buyers have started to emerge.

China's growth remains well above those of other large nations, while investors have used the weaker yuan as a cheap entry into a heavy dividend-producing stock market. The average dividend yield on Chinese stocks on the MSCI Emerging Markets Index is 3.1%, compared with 2.1% for the Standard & Poor's 500 Index.

That ratio is set to increase after the Shanghai Stock Exchange released new guidelines in mid-August that state a company will receive preferential treatment in financing if its dividend payout exceeds 50% of net profit.

Policy action from China could further boost stocks, investors say. London research firm Capital Economics forecasts Chinese policy makers will cut both benchmark interest rates and required reserve ratios by Sept. 30. China's government is already injecting capital into infrastructure projects in railways and energy conservation, with major Chinese cities set to roll out their own stimulus plans.

"China's got a lot of policy tools at its disposal, so we've never been worried about growth decelerating too much," said Marc Tommasi, head of global investment strategy at Rochester, N.Y.-based Manning & Napier, which manages $40 billion in assets and recently added Chinese stocks to its portfolio.

Mr. Tommasi's latest buy was Tsingtao Brewery Co. as the Chinese beer maker stands to benefit from an increase in domestic consumption, he said.

Write to Nicole Hong at [e-mail].