ECNS: Small-Cap China, A Good Cyclical Value Play

seekingalpha05-30

kritsapong jieantaratip Small-cap Chinese stocks are a good way to play a possible upswing in cyclical value. Although these stocks tend to be of relatively low quality, they are also very cheap and ...

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Although these stocks tend to be of relatively low quality, they are also very cheap and ...</p>\n\n<a href=\"https://seekingalpha.com/article/4696399-ecns-small-cap-china-a-good-cyclical-value-play\">Source Link</a>\n\n</div>\n","source":"seekingalpha_fund","html":"<!DOCTYPE html>\n<html>\n<head>\n<meta http-equiv=\"Content-Type\" content=\"text/html; charset=utf-8\" />\n<meta name=\"viewport\" content=\"width=device-width,initial-scale=1.0,minimum-scale=1.0,maximum-scale=1.0,user-scalable=no\"/>\n<meta name=\"format-detection\" content=\"telephone=no,email=no,address=no\" />\n<title>ECNS: Small-Cap China, A Good Cyclical Value Play</title>\n<style type=\"text/css\">\na,abbr,acronym,address,applet,article,aside,audio,b,big,blockquote,body,canvas,caption,center,cite,code,dd,del,details,dfn,div,dl,dt,\nem,embed,fieldset,figcaption,figure,footer,form,h1,h2,h3,h4,h5,h6,header,hgroup,html,i,iframe,img,ins,kbd,label,legend,li,mark,menu,nav,\nobject,ol,output,p,pre,q,ruby,s,samp,section,small,span,strike,strong,sub,summary,sup,table,tbody,td,tfoot,th,thead,time,tr,tt,u,ul,var,video{ font:inherit;margin:0;padding:0;vertical-align:baseline;border:0 }\nbody{ font-size:16px; line-height:1.5; color:#999; background:transparent; }\n.wrapper{ overflow:hidden;word-break:break-all;padding:10px; }\nh1,h2{ font-weight:normal; line-height:1.35; margin-bottom:.6em; }\nh3,h4,h5,h6{ line-height:1.35; margin-bottom:1em; }\nh1{ font-size:24px; }\nh2{ font-size:20px; }\nh3{ font-size:18px; }\nh4{ font-size:16px; }\nh5{ font-size:14px; }\nh6{ font-size:12px; }\np,ul,ol,blockquote,dl,table{ margin:1.2em 0; }\nul,ol{ margin-left:2em; }\nul{ list-style:disc; }\nol{ list-style:decimal; }\nli,li p{ margin:10px 0;}\nimg{ max-width:100%;display:block;margin:0 auto 1em; }\nblockquote{ color:#B5B2B1; border-left:3px solid #aaa; padding:1em; }\nstrong,b{font-weight:bold;}\nem,i{font-style:italic;}\ntable{ width:100%;border-collapse:collapse;border-spacing:1px;margin:1em 0;font-size:.9em; }\nth,td{ padding:5px;text-align:left;border:1px solid #aaa; }\nth{ font-weight:bold;background:#5d5d5d; }\n.symbol-link{font-weight:bold;}\n/* header{ border-bottom:1px solid #494756; } */\n.title{ margin:0 0 8px;line-height:1.3;color:#ddd; }\n.meta {color:#5e5c6d;font-size:13px;margin:0 0 .5em; }\na{text-decoration:none; color:#2a4b87;}\n.meta .head { display: inline-block; overflow: hidden}\n.head .h-thumb { width: 30px; height: 30px; margin: 0; padding: 0; border-radius: 50%; float: left;}\n.head .h-content { margin: 0; padding: 0 0 0 9px; float: left;}\n.head .h-name {font-size: 13px; color: #eee; margin: 0;}\n.head .h-time {font-size: 11px; color: #7E829C; margin: 0;line-height: 11px;}\n.small {font-size: 12.5px; display: inline-block; transform: scale(0.9); -webkit-transform: scale(0.9); transform-origin: left; -webkit-transform-origin: left;}\n.smaller {font-size: 12.5px; display: inline-block; transform: scale(0.8); -webkit-transform: scale(0.8); transform-origin: left; -webkit-transform-origin: left;}\n.bt-text {font-size: 12px;margin: 1.5em 0 0 0}\n.bt-text p {margin: 0}\n</style>\n</head>\n<body>\n<div class=\"wrapper\">\n<header>\n<h2 class=\"title\">\nECNS: Small-Cap China, A Good Cyclical Value Play\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-05-30 19:14 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4696399-ecns-small-cap-china-a-good-cyclical-value-play><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>kritsapong jieantaratip Small-cap Chinese stocks are a good way to play a possible upswing in cyclical value. Although these stocks tend to be of relatively low quality, they are also very cheap and ...</p>\n\n<a href=\"https://seekingalpha.com/article/4696399-ecns-small-cap-china-a-good-cyclical-value-play\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"BK7102","symbol_name":"机场服务","start_time":0,"source_url":"https://seekingalpha.com/article/4696399-ecns-small-cap-china-a-good-cyclical-value-play","article_id":"2439643879","we_media_id":null,"thumbnails":["https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1461543407/image_1461543407.jpg"],"rights":null,"url":"https://stock-news.laohu8.com/highlight/detail?id=2439643879","pubTimestamp":1717067640,"columns":[],"sourceInfo":{"source_id":"seekingalpha_fund","name":"Seeking Alpha"},"weMediaInfo":null,"summary":"kritsapong jieantaratip Small-cap Chinese stocks are a good way to play a possible upswing in cyclical value. 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Although these stocks tend to be of relatively low quality, they are also very cheap and have broken out of their sustained downtrend of the last two years. With a number of correlated cyclical indicators, particularly commodity prices, beginning to recover, ETFs like the iShares MSCI China Small-cap ETF (NYSEARCA:ECNS) have a high probability of appreciating quite rapidly over the coming year. In the following analysis, I am going to look at key quality, value, trend, and momentum metrics for the largest holdings of ECNS to determine how the ETF as a whole should be classified, and I am going to then cross-reference those results with other macro factors. I have taken the top 30 holdings of ECNS for which data was available, constituting around 30% of the fund's holdings, and aggregated the data to come up with an estimate of small-cap Chinese equities historical financial performance. Here, I will primarily concentrate on those which seem to have had some relevance to ECNS's performance or which help to categorize it by style metrics. Before beginning that analysis, let's begin with a breakdown of the ETF itself. iShares MSCI China Small-cap ETF The investment objective of the ETF according to the iShares website is \"to track the investment results of an index composed of small-capitalization Chinese equities that are available to international investors [emphasis mine].\" The vast majority (around 90%) of the 200+ holdings are listed in Hong Kong, with most of the remaining 10% being listed in the US. The fund tracks the MSCI China Small Cap Index and has an expense ratio of 0.59%, the same for the iShares MSCI China ETF (MCHI), much higher than a plain emerging markets ETF like SPDR Portfolio Emerging Markets ETF (SPEM) with an expense ratio of 0.07% and a 30% allocation to China.ECNS has struggled to keep up with SPEM over the last 14 years, especially as the selloff in small-cap Chinese equities of the last three years has gained steam. The following chart shows ECNS's performance over that period, alongside the ECNS/SPEM ratio (in orange). Chart A. ECNS is more cyclically volatile than broader emerging market ETFs. (Stockcharts.com) In other words, with its high expense ratio and weak long-term relative performance, ECNS looks less like a vehicle for long-term investing than an opportunity to play a shorter-term theme. More on that at the end of the article. Quality In the following chart, I calculate the median level of Return on Capital Employed, as described in Pulak Prasad's book, What I Learned About Investing From Darwin, in which the first hurdle a stock has to achieve is a relatively consistent 20% ROCE. This is the median ROCE for the top 30 holdings of ECNS for which I could find historical data on Quickfs.net. Chart B. Small-cap profitability has been falling in China. (Quickfs.net; author calculations) Twenty percent is a very high bar for most companies, never mind an index, but what is interesting is the rather steady decline in ROCE since the BRICS/commodity boom of the 2000s. Another quality metric is the debt level. In the following chart, I look at the equity/asset ratio. This has remained near the 60% level over the last seven years. Chart C. The equity/asset ratio is relatively high and stable. (Quickfs.net; author calculations) Finally, the investment cycle, which I measure by calculating the cyclical (log) rate of change in each of the 30 companies' total assets (the latest quarter divided by the three-year moving average) and then taking the median value over each period. Chart D. The investment cycle is near a 20-year low. (Quickfs.net; author calculations) This has reached the lowest level of the entire period. This number has tended to trough with the price of ECNS, probably as excess is slashed during lean times. Thus, the previous lows in the investment cycle were in 2010, 2013, 2016, and 2020, and this often corresponded with cyclical lows in ECNS. Chart E. Troughs in ECNS have tended to occur near investment cycle troughs. (Stockcharts.com) In sum, these are stocks with very low levels of profitability but relatively stable levels of debt, which have been sharply pulling back on the breakneck levels of expansion of fifteen - or even three - years ago. This bleakness has driven down valuations. Value The BlackRock website (see link above) reports the price/book ratio for ECNS at 0.79 (or, a book/market ratio of 1.26). In the following chart, I calculate the book/market ratio for the 30 selected stocks, which comes out at around 0.8 after eliminating goodwill. Chart F. The book/market ratio is well within value territory but it has been higher. (Quickfs.net; author calculations) This is not as high as extreme levels that were achieved in 2012, but this is near the highest levels of the last decade. However, if we take the eight-year averages of book values relative to current prices (as in the following chart), this number looks rather middling. Chart G. Cyclically-adjusted median book/market values are somewhat less impressive (Quickfs.net; author calculations) This number is around 0.65, which would be a price/book ratio of around 1.5. This is still significantly lower than the S&P 500's price/book ratio of 4. Finally, a cyclically adjusted earnings yield (calculated as the eight-year median of net income divided by current price) as shown below. This, too, is relatively high (over 6%) compared to the levels of the last seven years, but is not extraordinary. Chart H. The cyclically-adjusted earnings yield is high relative to US equities but is still not especially impressive. (Quickfs.net; author calculations) But, it is roughly double the cyclically adjusted yield on the S&P 500 (around 3%, if we invert Shiller's 10-year CAPE ratio). To sum things up thus far, small-cap Chinese equities are well within the value arena, particularly when looked at through the book/market lens, but they are not insanely cheap either. One thing I like to look at is the number of 'distressed' names there are in a given industry or asset class. Often, when this number has reached a certain threshold, the class as a whole has likely bottomed, even if some or all of those names are going to fail. In the chart below, I assign a score between 0 and 1, where 1 means a great degree of distress and 0 is no serious sign of distress. Chart I. Cyclical bottoms often occur near periods of increased distress at the firm level. (Quickfs.net; author calculations) Each company is assigned a 0 or 1 depending on a combination of levels and rates of change in prices, profitability, value, and indebtedness. These scores are then combined to produce the index distress score above. The peaks in distress were in 2014, late 2016, early 2019, and 2023-2024. The current distressed names in the group being tracked include GDS Holdings (GDS), which is listed on US exchanges. The YCharts chart below illustrates a sudden earnings-collapse in the earnings yield and the book/market ratio. Chart J. GDS has hit an earnings shock. (YCharts) It's not clear that GDS, a data center company, is itself an indicative of what precisely has caused the cascade of distressed names, as most of the names among the 30 are health care, industrials, and consumer discretionary stocks, which is itself roughly in line with ECNS's holdings, as can be seen below. Chart K. ECNS has a large concentration in cyclicals and health care. (iShares; author calculations) Rather, I am trying to illustrate that when a given class is under pressure, some constituents will experience a sudden shock, and this is often a signal that the class as a whole is bottoming. This signal can be boosted with the use of trend or relative strength metrics. Trend The following chart is a modified version of a 46-week price channel for ECNS. As you can see, ECNS has broken out to the upper range of that channel in recent weeks. Chart L. ECNS has broken its downtrend fairly decisively (Tiingo; author calculations.) But, it also did this in late 2022. The difference between late 2022 and now is that, although valuations are effectively the same as they were in 2022, the rate of firm distress has increased. In other words, the value case is marginally stronger than it was on the last attempt to break out. Relative Strength The chart below also illustrates the breakout in ECNS (in red), alongside other major Chinese equity ETFs such as FXI, GXC, EWH, and MCHI. Chart M. ECNS has underperformed most other China ETFs. (Stockcharts.com) The 12-month performance illustrated in the chart is a standard relative strength (or momentum) metric. It shows that ECNS is lagging most of the other major China ETFs, which have performed rather abysmally compared to the rest of the world. Everybody has their own particular way of measuring momentum. My favorite calculation is the number in the 'Strength' category in the following table. It shows ECNS only barely edging out CQQQ. Chart N. Chinese ETFs have broken out into bullish trends, but ECNS still has extremely weak momentum. (Tiingo; author calculations) It also shows the performance of each the China ETFs relative to US Treasury ETFs, confirming the underlying trend strength of recent weeks. But, the takeaway from the relative strength indicators is that ECNS is not a momentum buy at all. Macro Conditions China small-caps are not a screaming value buy. Profitability has been low (4% ROCE) and falling for years. Valuations are cheap (a bit more than book value), but they have been cheaper before. But, many of the constituents have been under stress for some time, and they have broken out of their long-term downtrend. There is another reason to suspect that Chinese small-caps have a chance to bounce considerably higher in the relative near-term: macro cyclicality. Specifically, ECNS has tended to be positively correlated with the industrial metals/gold ratio, as can be seen in the chart below. This ratio is a good proxy for the 'market cycle', in which gold tends to lead the earnings and commodity cycle, and industrial metals tend to coincide with the earnings cycle. Chart O. ECNS has been susceptible to both long-term and cyclical global macro forces. (Stockcharts.com) As I argued in April, the market cycle appears to have reignited in the spring, thus driving up the industrial metals/gold ratio, and perhaps only coincidentally, ECNS's performance, as well. The panels at the bottom also illustrate the risk that comes with ECNS. It has a long history of underperforming Hong Kong (the EWH ETF, with the ratio in yellow), except during cyclical booms, and EWH has underperformed SPY (this ratio is in orange) for a good 15 years, ever since the peak in the BRICS/commodity boom of the 2000s. Long-term relative performance versus the SPY tends to be negatively correlated with dollar strength (in green at the bottom). Why not EWH or SPY, then? A good case could be made for either, but ECNS has some advantages over each. Space does not permit, but in a similar, unpublished analysis on EWH, I could not find the same degree of distress or undervaluation that I could find in ECNS. And, SPY obviously has much stronger momentum with a nice AI theme justifying the nosebleed US valuations. But, emerging markets, and especially Asian equities, provide a strong element of long-term diversification to a portfolio. I use the iShares Asia 50 ETF (AIA) to get much of this diversification, but I have started adding ECNS to boost the value and cyclical side of things. Geopolitical Risks It is no longer a secret that China is seeking to become, at minimum, the unrivalled regional hegemon within the next decade, and that this goes hand in hand with the elimination of the Taiwanese sovereignty either through intimidation or outright invasion. US failure in Afghanistan, the Russian invasion of Ukraine, the US/EU/NATO failure to chart a course for Eastern Europe, the increasingly combustible Middle Eastern situation, and the unpredictability of US politics are all potential accelerants to a full-blown Asia-Pacific war. ETFs that contain assets on the wrong side of a geopolitical fault line can be badly damaged by the outbreak of a regional war, as happened with the Central and Eastern Europe Fund (CEE), which is still 63% below its pre-war peak, even as Polish stocks (EPOL) have approached long-term highs. Chart P. Eastern European equities long-term performance was badly damaged by the Russia-Ukraine War. (Stockcharts.com)Chart Q. Russia-linked ETFs never recovered from the invasion's aftermath. (Stockcharts.com) There are a few differences, however. Chinese equities are not near a cyclical peak. And, although there is a steady increase of geopolitical pressure building in and around Taiwan, the Philippines, and the Korean Peninsula, among other regions on China's periphery, it is unlikely that war is imminent. China would much prefer to swallow Taiwan whole, as it did Hong Kong, and its campaign of military intimidation is only in its first innings. Conclusion Small-cap Chinese stocks are not a good long-term investment. The Chinese economy is subject to the vagaries of China's domestic politics, and China is deliberately entering a period of confrontation with the West and its Asian neighbors in pursuit of a quasi-messianic notion of Chinese 'reunification' and manifest destiny, a mission that had been put on the backburner, so long as economic growth was high. This is likely to result either in a complete breakdown of globalization as we have known it and/or a breakdown in China's domestic political situation, and that is likely to permanently inhibit China's long-run economic potential.  However, we have not yet reached that point, and in a world in which US valuations are so high and Chinese valuations are so low, and a reignition of cyclical momentum appears to be underway, ECNS is a good way to bet on some of those temporary headwinds.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2439643879"}