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Chinese to Return to Luxury Stocks Over Basics: Chart of the Day

Shares of Chinese companies that provide basic consumer needs and those that offer discretionary products are diverging by the most in 16 months, a trend that is poised to halt as China takes steps to boost economic growth.

The CHART OF THE DAY shows the relationship between the MSCI China Index’s consumer staples gauge and the discretionary measure is at the lowest since February 2011, data compiled by Bloomberg show. The correlation coefficient based on 120-day observations has ranged between 0.63 and 0.66 since May 28. The relationship averaged more than 0.80 during a six-month period through March. A reading of 1 indicates the indexes move in lockstep, while a value of zero shows there is no relationship.

The discretionary index, made up of Chinese companies listed in Hong Kong that range from Gome Electrical Appliances Holding Ltd. to automaker BYD Co., has dropped 6.2 percent this year on concern the Chinese are cutting back on big-ticket purchases as the economy cools. It’s the worst performer among 10 industry groups. The staples gauge has gained 1.6 percent.

Valuations of companies that make basic goods “are quite stretched and competition remains quite fierce, so there are more risks,” Gigi Chan, a fund manager at Threadneedle Investments, which has $123.1 billion in assets under management, said in a June 14 interview in Singapore. “We are finding more interesting ideas in the discretionary space.”

HSBC Holdings Plc’s Hong Kong-based strategist Steven Sun also recommends discretionary stocks, citing valuations, falling interest rates and economic growth. “Cyclical” stocks trade at 12 times estimated profit on average, or at a 20 percent discount to the five-year average, compared with 15 times for “defensive” companies, the same discount at the end of 2008, Sun said in a report. China announced on June 7 a cut in borrowing costs for the first time since 2008.

The 19-company discretionary gauge also includes luxury-watch retailer Hengdeli Holdings Ltd. and Geely Automobile Holdings Ltd., while the 11-company staples measure includes diaper maker Hengan International Group Co., Wumart Stores Inc. and China Mengniu Dairy Co.

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