Michael Burry Is Betting the House on Chinese Stocks and This Billionaire Investor Is Too. Should You Follow Them?

Even if you're just a casual investor, there's a good chance you're familiar with Michael Burry. He's the contrarian hedge fund manager made famous by The Big Short, the Michael Lewis book-turned-movie that chronicled the investors who saw the 2008 collapse of the financial system early and bet accordingly.

Burry's Scion Capital Management made $725 million for his investors by betting against mortgage-backed securities back then, and he pocketed $100 million for himself.

The hedge fund manager has since been closely followed by investors, and though he doesn't frequently give interviews, anyone can track his moves each quarter through Scion's 13F filings with the SEC. Burry's recent purchases show that he's squarely lining up behind another contrarian bet.

Burry's portfolio

The Scion Capital manager now has approximately 46% of his portfolio in a trio of Chinese tech stocks. Alibaba (NYSE: BABA) made up 21.3% of his portfolio as of the end of the second quarter, followed by Baidu (NASDAQ: BIDU) at 12.4%, and JD.com (NASDAQ: JD) at 12.3%. Burry started buying those stocks in Q4 2022.

The past few weeks notwithstanding, it's hard to find a more unloved sector than China in recent years. As you can see from the chart below, the iShares MSCI China ETF, a top China ETF, has badly underperformed the S&P 500.

MCHI data by YCharts

The gains over the last few weeks are related to Beijing's move to loosen lending rates and restrictions, a sign that Burry's patience could be paying off.

David Tepper's portfolio

He's not alone. Billionaire fund manager David Tepper, who runs Appaloosa Management, has also been stocking up on Chinese stocks. Tepper's top holding is also Alibaba, representing 12.2% of his holdings, and Pinduoduo parent PDD Holdings (NASDAQ: PDD) makes up another 4.2%. He also owns Baidu, the Kraneshares CSI China ETF (NYSEMKT: KWEB), JD.com, and KE Holdings (NYSE: BEKE), which represent a combined 6.6% of his portfolio.

All totaled, nearly a quarter of Tepper's holdings are Chinese stocks, and he first started buying the sector, starting with Alibaba, in Q2 2022.

Should you follow these top investors into China? Let's take a look at one reason to buy Chinese stocks and one reason not to.

Image source: Getty Images.

The valuation gap is stark

Plenty of top investors seem to think the U.S. stock market, as represented by the S&P 500, is overvalued. Even Warren Buffett, one of the biggest cheerleaders for U.S. stocks in history, has been a net seller this year, instead piling into Treasuries.

However, Chinese stocks are undeniably cheap. The iShares MSCI China ETF, which counts Tencent and Alibaba as its top two holdings, trades at a price-to-earnings ratio of 11.6, compared to the iShares Core S&P 500 ETF valued at a P/E of 29.4.

As investors have snatched up AI stocks like Nvidia, the S&P 500 has gotten unusually expensive, leading investors like Burry and Tepper to look elsewhere for stronger returns. Based on that valuation gap, expectations for China stocks are much lower, which means even modest growth from the sector could lead it to outperform the S&P 500.

Why China still deserves caution

Many investors have gotten burned by Chinese stocks over the last few years, and the circumstances that led to their weak performance haven't significantly changed.

While interest rates are declining and Beijing seems to be adopting a more accommodative monetary stance, the Chinese economy is still weak, consumer spending is down, and it could take more than lower interest rates to change that.

At this point, it still seems unlikely that stocks like Alibaba and JD.com will return to their pre-pandemic growth rates, and U.S. chip export bans could also make it difficult for China to keep pace with the U.S. in new technologies such as AI. Meanwhile, the risk of another crackdown on the sector like we saw in late 2020 with the blocking of the Ant Financial IPO is very real.

While China stocks may be cheap, there's still a lot of risk in the sector even at a low valuation.

Should you buy Chinese stocks?

I think most Chinese stocks are best avoided until it's clear the economy is on stronger footing. But there is one Chinese stock worth considering.

That's PDD Holdings. The parent of Pinduoduo and Temu has consistently outperformed Alibaba and JD.com, despite the weak Chinese economy, and is still growing rapidly. Temu has also had success in international markets, giving it a valuable new revenue stream.

That stock has been a winner recently despite the malaise in China and trades at a cheap valuation. It's the best bet to outperform in the sector.

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Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Baidu, JD.com, Nvidia, and Tencent. The Motley Fool recommends Alibaba Group. The Motley Fool has a disclosure policy.