The late Charlie Munger, Warren Buffett’s longtime investment partner, steadfastly endorsed Chinese investments despite the economic challenges faced by China. In a 2023 interview, Munger expressed his confidence, stating, “the Chinese economy holds more promising prospects for the next two decades than almost any other major economy.”
Munger and Buffett have consistently been at the forefront of global “value” investing for decades, showcasing how their success serves as a testament to the rewards of patience and persistence in navigating undervalued assets.
The humble view here is underweighting Chinese stocks is deemed too risky given their currently inexpensive valuations. Like other market observers, I will be closely monitoring any policy moves from the Chinese central government that could trigger a return of foreign capital to China.
Any market response is expected to be swift, leading to a substantial surge in Chinese stocks on any positive announcements from the government. In other words, patience and perseverance will likely pay off handsomely when the situation improves. Another timely report from a partner just hit my desk.
Here is a section:
Sentiment and capital flows, not fundamentals, dominated market movements in 2023. That was tough for fundamental investors like us, because fundamentals generally do not matter in a period of mass exodus.
Proof of this can be seen in liquidity for the Hong Kong stock market, which declined significantly in 2023. Daily average turnover fell by 16% yoy last year, down 37% from the peak in 2021 and back to levels comparable to 2015 when the Stock Connect scheme first started.
Valuations in China are currently at rock bottom on any measure. Chinese equities are cheaper than during the 2008 financial crisis, and our portfolio is trading at an unprecedented 8x P/E. Amazingly, almost 20% of our holdings are trading below their net cash levels, implying that many of our Chinese companies will need to burn more than 25% of their cash reserves to remain operational.
The environment described by the mathematical data points that support present valuations is counter to what we see on-the-ground. Almost every company within our portfolio reported improving cash conversion cycles last year.
Fundamentals for our businesses also remained strong throughout 2023, and our portfolio companies outperformed the index from an earnings perspective, delivering over 60% earnings growth in the first half of 2023 vs almost no earnings growth for the index. With any normalization of market conditions, investors will re-focus on fundamentals and companies with strong earnings will rerate.