In a recent welcomed, yet somewhat unexpected, announcement, the Chinese government indicated that it is taking measures to open up its domestic banking sector to foreign players. So, what’s at stake for interested foreign banks wanting to do business in China? A slice of a more than US$44 trillion pie!
Our China-bank thesis hinges on several assumptions that are steeped in reality:
- Most China-watchers, including global accounting giant Deloitte and the International Monetary Fund (IMF) see China’s economic growth continuing to have a six-handle (in the mid to low 6% range) over the next year or two
- Data from IMF, the OECD, and other China-watchers indicates that, over the past several years, China has been steadily reducing its exposure to the rest of the world and replacing that reliance with domestic demand as the growth engine for its economy
- The U.S. economy grew by an annualized rate of 2.2% in Q4-2018 (versus an estimate of 2.6%), compared to 4.2% and 3.4% in Q2-2018 and Q3-2018 respectively
- Over the next several quarters, the U.S. economy is expected to cool down, with quarterly growth forecasts over the next eight quarters ranging from 1.0% to 2.8%
Given all of these “known unknowns”, it’s hard to predict with any certainty what may happen in the future. However, there’s one probability that’s inching towards certainty:
- Neither China nor the U.S. wants the currently simmering trade tensions to boil over!
Why? Because, even though China’s economy has been relatively “stable”, it’s still off the 7+ percent it is hoping to continue to achieve. And also because, even though the U.S. economy is relatively better off than most western nations, with an election just around the corner, the U.S. Administration wouldn’t want to jeopardize the stable growth enjoyed by the U.S.
And that can only mean that both parties want to hammer out a trade deal ASAP. The signs are encouraging thus far. Most news agencies believe that the next week or so might be crucial, with more optimism than pessimism creeping into the outlook. The loosening of foreign bank participation is a sign of that optimism.
China’s Vice-Premier Liu He is scheduled to visit Washington later this month. If that meeting goes ahead as planned, that would be yet another positive signal for our thesis.
If, as indeed looks very likely so far, a trade deal is finalized between the U.S. and China, the banking sector is probably the best bet to benefit from such an agreement. And if you want to position your portfolio to ride that wave, then you should stick with the best-of-breed U.S. banks to do so.
How You Could Turn “Extra Cash” Lying Around Your House into Thousands of Dollars In as Little as 23 Days
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JPMorgan Chase & CO (JPM)
On the financial performance front, JPM has shown how strong it is when it comes to delivering shareholder value. Despite global headwinds in late 2017 and through most of 2018, the bank has delivered improvements in every financial metric- Net Revenue, Profits, and Net Income.
So, what’s all this have to do with China? A lot, actually!
First of all, let’s see what top leadership thinks about the China story. In the latest Annual Report (2018), Jamie Dimon, Chairman, and CEO of JPM said: “…The investments we are making in China and in other emerging markets today will result in our international growth for years to come.” Coming from Mr. Diamond, that in itself is a long-term bullish call on China and its banking future – regardless of a deal. It’s no wonder then that the bank has increased its China exposure to 19.3% in 2018, from 16.3% in 2017.
Want more proof that renewed China-interest will only be a good thing for JPM? Well, let’s look at how the bank has rewarded its shareholders over time, versus portfolios that may have bet on a broader index.
Clearly, investors that put their faith in JPM would have beat most major indices by a long shot! A renewed China-interest will definitely reward investors in similar measure – if not more. However, patience is in order because there could very well be near-term shocks.
Other China Banking Bets
JPM is currently trading at Forward P/E of around 10.93x, with a PEG Ratio (indicative of future growth) of 1.19. However, while JPM is our go-to for future China leveraged growth, you could also consider Bank of America Corporation (BAC) for the same theme as we spoke of earlier. Many analysts believe that any Sino-U.S. trade deal would immediately send BAC share prices off to a flying sprint!
On a Forward P/E valuation basis, BAC is trading slightly lower (9.75x) than JPM, however, with a 5-year PEG Ratio of 0.52, BAC isn’t expected to grow its earnings as quickly as JPM. Still, this is a safe bet to add growth to any China-hinged portfolio.
If you are less of a stock-picker and more of a passive investor, then an ETF approach might be worth considering. Global X MSCI China Financials ETF (CHIX) is a basket of large- and mid-capitalized banks and financial institutions in China.
While any China-U.S. deal would definitely mean more competition for domestic Chinese banks/financial institutions, it would also open up those institutions to foreign partnerships, which could then give them global/U.S. reach. Adding CHIX to your portfolio could give you exposure to such an outcome. Be mindful though, that this ETF does come with a comparatively high MER of .65%. But with a 3 and 6-month return of 8.44% and 18.93% respectively (43.81% since inception in 2009), those fees might be worth it.
As with any investment thesis, there are risks to this one too. Most important of those risks is a no-deal scenario. If that happens, all bets are off! A more likely version of that pessimistic scenario is a “less optimistic” event where a deal is hammered out, but Wall Street greets it with some skepticism. Of the two scenarios, and given all the recent flurry of activity by senior bureaucrats and government functionaries on both sides, the latter is more likely than the former.
In case a deal is struck, and it receives a lukewarm reception from the investment community, all the three names discussed here would likely drop lower than they are today. However, with China’s already announced loosening of banking-sector rules, such a decline is likely to be a temporary phenomenon.
The author does not have an investment in stock discussed in this article.