David P. Goldman, a well-known economist and analyst who held various senior positions at Credit Suisse, Bank of America, Cantor Fitzgerald and Asteri Capital, recently opened up about the current market crash. In an article published in Asia Times, he discussed, in detail, the outlook for global equity markets and the sectors that he is betting on during this plunge. American consumer staples companies, well-managed utilities and European automakers are among the sectors the guru is bullish on. What stands out, however, is his comments about Chinese tech companies. Goldman wrote:
“The first is tech companies with strong market positions, steady top-line growth, and little debt. China’s tech companies were outperformers during 2019 and 2020 to date and remain my favorite sector. There are two ETFs, KWEB and CQQQ, that offer a diversified portfolio of Chinese tech companies.”
It takes both courage and expertise to go against the grain when markets are crashing. Legendary investors, including Warren Buffett (Trades, Portfolio), have done this on numerous occasions, and that is what fueled their success.
Today, many investors are avoiding the Chinese equity markets altogether and flocking to safe-haven assets such as gold and dollar-denominated investments. In this analysis, I will discuss Goldman’s favorite sector in-depth to identify whether one of his recommended ETFs, the KraneShares CSI China Internet ETF (KWEB, Financial), is an attractive investment.
A surprising outperformance
The novel coronavirus (Covid-19) outbreak was first reported in Wuhan, China. As of March 16, more than 80,000 cases were confirmed in China. Considering these numbers, it would be a no-brainer to conclude that equity markets in this East Asian nation would have suffered the most on a global scale, which is far from the truth. Surprisingly, Chinese equity markets, as measured by the CSI 300 Index (which is the benchmark for large-cap stocks), have outperformed their American peers by a considerable margin in 2020, as shown below.
Source: Bloomberg
The resilience of Chinese stocks has almost gone unnoticed amidst the chaos. Since there’s no guarantee that history will repeat itself, the more important question is whether this outperformance can continue.
The path to recovery and the potential winners
An analysis of Chinese equity markets that doesn’t begin with a quick note on Covid-19 and its impact on the economy has gone out of fashion for all the right reasons. Industrial activities in China, along with manufacturing, will take a massive hit in the first half of this year as most of the factories were shut down to facilitate the government’s quarantine efforts. Bloomberg reported on Monday that that industrial output in the country has fallen as much as 13.5% in January and February on a year-over-year basis, in comparison to a previous estimate of 3% contraction. The unemployment rate in China reached 6.2% in February, the highest on record.
However, there’s reason to believe that major tech companies in China are in a much better position to fight virus fears than their industrial counterparts. First, the lockdown of many cities across the country was an opportunity for e-commerce companies to grow their market share in the Chinese retail industry. According to data from Statista, online sales accounted for approximately 36% of the total sales in the country in 2019, and this market share has risen considerably from just 12.4% in 2014. Access to the internet and the rapid growth of personal disposable income were behind this increase in e-commerce sales. The novel coronavirus outbreak and the lockdown will be a catalyst for leading players in this industry to gain new customers as consumers who had no hands-on experience in purchasing products online would now have had a chance to realize the benefits associated with it.
Alibaba (BABA, Financial) has the lion’s share of this sector in China, and none of its competitors are in a position to threaten the market leadership of this Chinese tech giant.
Source: Statista
The demographic factors are favorable for the further growth of these companies as well. For instance, China is the country with the highest number of internet users by far.
Source: Internet World Stats
There is room for further growth as the internet penetration rate is still around 60% in China in comparison to around 90% in North America and Europe, according to data from Bloomberg. Along with the economic growth of the country and the planned infrastructure development projects, a much higher percentage of Chinese residents will have access to the internet, which would be a growth factor for companies such as Alibaba and JD.com (JD, Financial), whose success depends on this target market.
The rising middle-income society in the country would be another factor that fuels the growth of online retailers. A research conducted by the Department of Economics at the Pace University revealed that the purchasing power of Chinese households has exploded in the last decade and would likely continue on the same path for several more years before a slowdown. The same way it happened in the United States, such a phenomenon will lead to an uptick in the number of consumers who are focused on convenience, which is a positive sign for online store operators.
Another company that would immensely benefit from the recent developments is iQIYI, Inc. (IQ, Financial), which is the Netflix equivalent in China. With many people opting to reduce their travel activities and work from home, the video streaming giant will likely report a surge in viewership. As the leading over-the-top content streaming platform in China, the company is in a good position to translate this anticipated gain into long-term profits by showcasing its high-quality content to new users.
Baidu, Inc. (BIDU), the leading search engine in China and the holding company of iQIYI, is another attractive play given that internet usage will likely reach new highs along with the expected growth in the number of users.
While tech companies will be at the center of the recovery of the economy due to the favorable demographic situation, it’s safe to conclude that the country is well on its way to resuming the normal course of business activities. On March 10, the Harvard Business Review reported encouraging data regarding travel, energy consumption and real estate transactions.
Source: Harvard Business Review
As China returns to its normal economic state, tech companies will resume their growth stories. As Goldman suggests, there is significant upside potential.
One fund to capture this growth
Investing in equity securities of the companies discussed above is one way to benefit from this projected stellar performance. However, a safer way would be to invest in a collective scheme, such as an exchange-traded fund (ETF), as this provides diversification benefits. KraneShares CSI China ETF (KWEB, Financial) is one of the best such funds because of its high concentration of the tech sector. The top-10 holdings account for nearly 60% of its assets, and not surprisingly, this list consists of the largest tech companies in China.
Source: Factsheet
At the end of 2019, large-cap stocks accounted for 83% of the fund, according to data from KraneShares. This is an indication of the focus on profitable, industry-leading names. Since the beginning of this year, the market price of the ETF has declined due to external pressure from sources including the coronavirus outbreak. This presents a good entry point for long-term oriented investors.
Source: Bloomberg
Even though the ETF might remain volatile in the short term, the market price would follow corporate earnings in the long term, and the outlook from this front is promising.
Takeaway: gurus agree on the economic prospects for China
Goldman is not the only guru bullish on China. At the annual meeting of Daily Journal Corp. in February, Charlie Munger (Trades, Portfolio) said, “The strongest companies in the world are not in America. I think Chinese companies are stronger than ours and are growing faster.”
The deaths reported as a result of Covid-19 are truly tragic, and as Bill Gates (Trades, Portfolio) pointed out in 2015, the world needs to be more proactive in identifying pandemics and containing such catastrophic events. Allocating more resources, both human and financial, is the only way to prevent another virus outbreak that could cost thousands of human lives.
As investors, however, there’s no better time to focus on the economic impact of this virus. While short-term oriented investors and analysts are staying away from Chinese equities, contrarian investors should look for opportunities in this growing nation. The World Bank projects China to become the world’s largest economy by 2050, surpassing the United States. The tech sector will be at the center of this growth, and today, there’s an opportunity to buy shares of companies that are changing the lifestyles of billions of Chinese people. KraneShares CSI China Internet ETF, in my view, is one of the best funds positioned to deliver stellar returns to investors as this story plays out.
Disclosure: I do not own any stocks mentioned in this article.
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