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 Thursday, November 06, 2008
October 2008 Newsleter: Extreme volatility shatters value stocks. How to play it safe?

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Extraordinary times. This comes in mind first when I’m looking back to the month of September. Extraordinary volatility, events and an outlook that’s still uncertain. October 2nd. may be a better time to find directions for the market following the vote in the House but for now we have to focus on past events. Looking at the chart tracking major indices in 2008 doesn’t make investors smile. The DJIA lost over  20% by September 29 though it came back 485 points on the 30th—the best day in six years. But make no mistake, the third quarter of this year was one of the worst for China stock investors since 2001.

Shanghai fell only 0.04 percent in September thanks to stepped-up government support. Authorities have started buying into state-owned large companies, and banks in particular. Considering that China is sitting on a $1.8 trillion foreign reserve, there is room for improvement. Let’s just pause for a moment: China has been running a fiscal surplus since 2002 enabling the  overnment to launch economic stimulus plans if needed.

The risk Chinese shares are facing is lower GDP growth –from over 10% to 8-9%, an increase in bad debt due to slowing growth environment, and an accelerating inflation. On the other side Chinese shares are cheap in our opinion, trading on a multiple of 11.2 times 2008 earnings and 9.6 times estimated 2009 earnings. Revised company growth data suggests that profit growth is 12.9% this year and 16.9% for 2009 compared to 2007. Profit outlook is strong for all sectors but real estate - a sector that has no representative on American exchanges.

Stock prices should reflect longer term view of companies’ profits but recent market volatility suggests otherwise. But make no mistake: Asian debt levels are low, inflationary pressures are easing as commodity and food prices fall, and while overall economic slowdown is unavoidable, it would be a mistake to quit on China. But as far as the immediate future goes, we live in extraordinary times. The Senate is to vote on the plan on October 1st—probably it will pass. But what happens on Thursday will determine shot and long term performance of equities globally.

Given the tremendous impact of the “bail out” plan on American stock markets, this Newsletter is nontraditional in a sense that t will give investors guidance for the upcoming days versus a month. To put latest developments into perspective we provided the following two charts. The first one is a candlestick chart of the DJIA for the last six months. The second is just a blow up of events in the last two weeks. We saw the biggest point drop of the DJIA on September 29, just to see a 485 point comeback the next day. So whatever happens on Thursday, October 2nd. and the following days, will have a lasting impact on equities.

Here is a recap of some extreme volatile days in the last two weeks of September. We woke up on September 15, Monday, to see Lehman go under along with Merrill - Cont. from Page 1 - Extreme volatility shatters value stocks. How to play it safe? though the latter was better off by selling herself to Bank of America. Then we learned that AIG might be next unless it can raise a significant amount of capital ASAP. So Monday was a disaster— the first large red column on the charts. Tuesday started out just as bad. The government's rescue plan to pump $85 billion into AIG didn't clam the markets as it seemed to save AIG but not tackle the underlying problem of the credit crisis. However news that global central banks pumped hundreds of  mllions of dollars into the system  started to take some of the pain away, saving Tuesday. Rumors on Wednesday that Morgan Stanley and Goldman Sachs will be next ruined the day, stocks tumbled. Thursday started out indecisive when news that Bank of England introduced a temporary ban on short-selling of financial assets. News that the FEDs may do the same started a rally, but the boost came later in the day when we learned that Secretary Treasury Mr. Paulson is ready to pump government funds into buying illiquid assets off troubled company's balance sheets.

DJIA April 1—September 30, 2008

 

DJIA September 15—30, 2008

This sent all major indices shooting for the moon. This set the tone for the rest of the day, making Friday another stellar day. Last week of September was just as crazy. Once the House rejected the rescue bill, stocks nosedived sending the DJIA down a record 777 points on a single day. And if this was not enough, the last day of September experienced another extreme market day, the DJIA rallied 485 points—the best in six years. Assuming that we’re facing similar extreme volatile trading days, we will give you guidance what Chinese stocks are safer than others and what stocks you want to avoid.

Our assumption is that whatever these stocks did on the last few extreme market days, they will likely do the same again. Regarding the method we used, we tried to keep it simple: we looked up trading characteristics for each and every Chinese ADR for these extreme market days between September 15 –30. We focused on risk, average return, biggest gain and largest loss for each stock. Then we sorted the table based on risk with the most risky on top. We used volatility for the measure of risk—the more volatile a stock is the more risky it is considered. Risk score is in the first column and the higher the number the more risky the asset. Next column stands for the average return of the ticker between September 15-30. In this case the DJIA lost an average –0.6% from September 15-30. The next column displays the largest single daily drop of the ticker - in our cased the DJIA lost -7.0% in single day. And the last column stands for the largest single daily gain—in our case the DJIA gained 4.7% on September 30.
RETURN: Sept. 15-30, 2008
  RISK Average MIN MAX
DJIA   0.03 -0.6% -7.0% 3.9%
CTRP   0.15 -0.1% -11.6% 44.3%
GRRF   0.13 -5.2% -34.7% 16.7%
TSL   0.12 -0.8% -19.9% 25.4%
ZNH   0.12 -3.5% -33.0% 10.4%
ASIA   0.11 -1.1% -17.8% 28.0%
CNTF   0.11 -0.3% -13.5% 22.0%
JASO   0.11 -1.7% -20.3% 16.6%
FMCN   0.11 1.2% -14.2% 20.6%
JRJC   0.10 -1.1% -20.6% 15.9%
XFML   0.09 -1.7% -14.5% 14.5%
CEA   0.09 -0.5% -14.9% 12.4%
UTSI   0.09 1.5% -11.4% 16.4%
CHA   0.09 -0.5% -12.5% 17.2%
ACH   0.09 -1.6% -14.1% 18.4%
CN   0.09 0.2% -9.5% 23.7%
CHU   0.08 0.3% -8.0% 22.5%
BIDU   0.08 -0.7% -11.3% 20.0%
CEO   0.08 -0.5% -14.3% 14.9%
HNP   0.08 -1.1% -14.5% 10.4%
EJ   0.08 -2.0% -11.5% 13.5%
YZC   0.08 -1.3% -13.3% 16.4%
CHL   0.08 0.1% -9.7% 17.2%
PTR   0.08 -0.6% -13.4% 11.0%
HRAY   0.07 -0.1% -18.5% 15.4%
STP   0.07 -1.2% -16.3% 7.5%
STV   0.07 -0.1% -10.1% 11.6%
SMI   0.07 -3.0% -13.3% 12.9%
SNP   0.07 -0.9% -14.2% 10.8%
SINA   0.07 -0.7% -8.8% 15.6%
SOLF   0.07 -2.0% -15.7% 7.9%
SOHU   0.07 -0.8% -13.8% 8.4%
SHI   0.07 -1.3% -12.8% 7.9%
SSRX   0.07 -3.5% -14.7% 10.2%
SNDA   0.06 -0.5% -10.6% 9.4%
JOBS   0.06 -1.9% -15.9% 9.0%
LFC   0.06 0.3% -9.9% 9.4%
GSH   0.06 1.0% -8.1% 10.5%
NCTY   0.05 -0.6% -9.1% 10.0%
NTES   0.05 0.0% -9.4% 9.9%
KONG   0.05 -0.7% -9.5% 5.4%
AOB   0.05 -0.5% -10.3% 7.1%
COGO   0.04 -0.8% -7.4% 6.5%
HBC   0.04 0.2% -4.7% 9.1%
HTX   0.04 -1.0% -7.6% 2.8%
LTON   0.03 -1.1% -7.5% 3.2%
LONG   0.01 -0.2% -2.0% 1.9%

As the table shows, Ctrip.com (CTRP) was the most volatile  stock among Chinese ADRs during the examined period. It recorded a 44% gain on a single day! On the negative side China GrenTech Corp. dropped 34.7% just in one day. As the table suggests, solar companies and airliners were among the most risky assets to own during these turbulent times. But a further break-down of events may be even more useful predicting the future. We separated big market days when the market went down from those when it went up. The first ones we called  Extreme DOWN Days. The following table shows you the ones we considered to qualify.

Extreme DOWN Days
Date DJIA change
9/15/2008      (504.48)
9/17/2008      (449.36)
9/29/2008      (777.68)

The idea is that should the market experience another extreme plunge, you will have an idea how your Chinese ADR did behave during those days. Or if your stock is extremely risky, you may want to pull out before such event occurs. Looking at the table on the  right, the worst stock to own on a big negative market day was China GrenTech Corp. (GRRF). Not only was this company the most volatile or risky but recorded the largest single daily loss and lost a staggering 21.4% on average when the market plunged.

RETURN: DOWN-DAYS
   RISK  Average MIN MAX
DJIA    0.02 -5.2% -7.0% -4.1%
GRRF       0.12 -21.4% -34.7% -11.1%
TSL       0.10 -10.6% -19.9% 0.2%
HRAY       0.10 -6.9% -18.5% 0.0%
JASO       0.10 -13.0% -20.3% -2.0%
ASIA       0.10 -7.7% -17.8% 1.2%
JRJC       0.09 -10.4% -20.6% -2.7%
JOBS       0.08 -6.6% -15.9% -0.5%
STP       0.08 -7.5% -16.3% -0.2%
SOLF       0.08 -6.7% -15.7% -0.2%
SOHU       0.06 -7.7% -13.8% -1.1%
SSRX       0.06 -10.2% -14.7% -3.2%
FMCN       0.06 -9.0% -14.2% -2.5%
LTON       0.05 -0.3% -6.1% 3.2%
SNP       0.05 -9.6% -14.2% -4.5%
SMI       0.05 -9.9% -13.3% -4.5%
HNP       0.05 -9.2% -14.5% -5.7%
KONG       0.05 -5.0% -9.5% -0.2%
BIDU       0.04 -6.3% -11.3% -3.2%
GSH       0.04 -3.9% -8.1% 0.6%
NTES       0.04 -4.5% -9.4% -1.6%
CEA       0.04 -11.9% -14.9% -7.0%
PTR       0.04 -10.9% -13.4% -6.0%
YZC       0.04 -8.8% -13.3% -5.3%
ZNH       0.04 -9.1% -11.9% -4.7%
STV