In a May 9, 2023, Barchart article, I wrote, “While Chinese stocks offer value on paper, and the Chinese economy could be eclipsing the U.S. over the coming years, the geopolitical tensions between Washington and Beijing remain a clear and present danger that could lead to trade barriers and even delistings of many of China’s leading companies trading on the U.S. and other foreign exchanges.”
The iShares China Large-Cap ETF (FXI) was trading at $28.34 per share on May 9. On July 18, the ETF was slightly lower and continued to underperform the leading U.S. equity indices, as what was cheap in early May became even less expensive in mid-July.
The FXI underperformed SPY, DIA, QQQ, and IWM
FXI was at $27.66 per share on July 18, 2023. The liquid ETF has over $5.275 billion in assets under management and trades an average of more than 26.6 million shares daily. FXI charges a 0.74% management fee. Meanwhile, FXI’s 0.75 cents annual dividend translates to a 2.71% dividend yield, which covers the FXI’s expense ratio for medium to long-term holders.
The ten-year chart highlights that FXI closed 2022 at the $28.30 per share level. At $27.66 on July 18, FXI was 2.26% lower since the end of last year. FXI has underperformed all of the leading U.S. stock market indices over the period:
- The DIA ETF that moves with the DJIA at $349.45 on July 18 was 5.47% higher than the $331.33 2022 closing level.
- The SPY that follows the S&P 500 at $452.23 on July 18 was 18.25% above the December 30, 2022, $382.43 closing level.
- The IWM that tracks the Russell 2000 small cap index closed 2022 at $174.36 and was 12.27% higher at $195.75 on July 18, 2023.
- The QQQ that follows the tech-heavy NASDAQ composite moved 43.1% higher from $266.28 at the end of 2022 to $381.04 on July 18, 2023.
The large-cap Chinese stock ETF (FXI) has been a laggard in the equities sector.
The Treasury Secretary travels to Beijing - Chinese GDP data remains bearish
The relationship between the Biden administration and the Chinese government has deteriorated since the February 2022 handshake alliance between President Xi and Russian President Putin. China’s support for Russia in the war against Ukraine and its reunification plans with Taiwan have caused a widening rift.
In July 2023, the U.S. administration dispatched Treasury Secretary Janet Yellen to Beijing to improve economic relations between the world’s leading economic powers, seeking healthy competition. The visit came as China restricted germanium and gallium exports. The metals are critical inputs in semiconductors and other technological products.
Meanwhile, China’s COVID-19 protocols continue to weigh on the Chinese economy. On July 16, China reported that second-quarter GDP came in short of expectations as the Chinese National Bureau of Statistics spokesperson said that China faces a complex geopolitical and economic international environment. Markets reflect the economic and geopolitical landscapes, which have caused investors to shun Chinese large-cap stocks.
A Chinese-led BRICS currency is on the horizon
The bifurcation of the world’s nuclear powers is causing significant changes in the global economy. China and Russia have been leading a shift towards non-dollarization or conducting international trade using non-dollar assets.
The U.S. dollar has been the world’s reserve currency for decades, making the U.S. currency the pricing benchmark for most commodities and international trade. Over the past years, the world’s central banks have been net buyers of gold, with China and Russia, leading gold-producing countries, increasing reserves by vacuuming domestic production. Since strategic gold holdings are state secrets in Beijing and Moscow, the rise in governmental gold ownership is likely understated.
With gold backing, BRICS countries have been working together to roll out a BRICS currency to challenge the U.S. dollar’s dominant role. Sanctions on Russia and other countries have led the BRICS countries to seek an alternative to the dollar.
Meanwhile, the U.S. dollar is a fiat currency, backed only by the full faith and credit of the U.S. government. A BRICS currency with gold backing could change the landscape for international commerce as Brazil, Russia, India, China, South Africa, and other countries are involved in the project to roll out an alternative to the dollar. Central banks worldwide continue to own gold as a foreign currency reserve holding. A BRICS currency could return part of the world to a gold standard, potentially threatening the fiat U.S. currency instrument.
The U.S. dollar index, which measures the U.S. currency against the other world reserve currencies, rose to a two-decade high in September 2022. Since then, the dollar’s value has been falling against its competitors.
The chart illustrates the dollar index’s drop from 114.745, the highest level since 2002, to below the 100 level last week. The dollar index has dropped to its lowest level since April 2022.
The index measures the U.S. dollar against the euro, British pound, Japanese yen, Canadian dollar, Swedish krona, and Swiss franc. While the index may recover from the bearish trend since the September 2022 high, a BRICS currency that replaces the dollar for many international transactions would likely cause the dollar’s dominant role to decline.
Gold and alternative asset prices could receive a boost from the dollar’s decline on the global stage.
As U.S. stocks rise, investors are looking for value
Meanwhile, the threat of a U.S. recession because of the trajectory of U.S. interest rate hikes has yet to materialized. The U.S. labor market remains tight, and wages are rising despite the recent declines in inflationary pressures.
The U.S. stock market has had a surprisingly bullish year in 2023 despite the rate hikes that took the Fed Funds Rate from zero in March 2022 to over 5% in July 2023. So far in 2023, all the leading U.S. stock market indices, including the S&P 500, DJIA, NASDAQ, and Russell 2000, have posted impressive gains.
With U.S. stock indices rising and the threat of a U.S. recession looming, investors may begin turning to markets that offer value with limited downside and the potential for upside appreciation. As of July 18, the price-to-earnings ratio of the diversified S&P 500 SPY ETF was 17.86, while the FXI’s P/E ratio was 10.62. FXI’s 2.71% dividend yield was substantially above the SPY’s 1.44%.
Downside risks continue, but the potential for gains may be worth the risk
On paper, FXI is an attractive bargain, given its price-to-earnings ratio, dividend yield, and subpar performance in 2023. However, the inexpensive Chinese large-cap stock ETF comes with many risks:
- Reporting and regulation of Chinese companies remain dubious compared to U.S. and European standards.
- The relations between Washington, DC, and Beijing remain strained, which could lead to trade issues and other barriers to FXI growth and performance.
- The trend is always your best friend in markets across all asset classes. The path of least resistance for U.S. stocks is bullish, while Chinese stocks remain in a bearish trend.
Meanwhile, value is critical, and investing in Chinese equities through FXI offers compelling value. On July 18, according to Seeking Alpha, FXI’s largest holding is Alibaba Group (BABA), with a 9.74% exposure.
The chart shows that BABA shares have made higher lows and higher highs since trading to a low of $77.77 on May 31, 2023. BABA rose to a high of $97 per share on July 13 and remains closer to the recent peak at over $90 per share on July 18.
FXI is a risky investment, given its price performance over the past years. However, the ETF offers value for contrarians seeking diversification away from U.S. equities. Even though the relations are at a low, China remains the world’s second-leading economy.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
