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Uncertainty creates opportunity for 2012

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new_year2 January, 2012 (Chinavestor)  I like to sum up what’s left behind and what’s coming up at the beginning of a new  year. One thing is certain, that uncertainty remains. The epicenter of economic trouble shifted to Europe in 2011 where the future of the common currency, the euro, is under serious question. This has had ramifications all over the world, from Shanghai to Hong Kong, New York and Tokyo. The Shanghai Composite Index (SHA:000001) fell 22.9 percent for the year after a 14.3% decline a year before. The Hang Seng Index (INDEXHANGSENG:.HSI), a hybrid between China and the west, fell even more for the last year, a staggering 24.3 percent!

The China DR Index, a composite of Chinese stocks listed in the U.S., fell 12.1% in 2011, beating the most liquid Chinese indices in Asia. Needless to say, all major European benchmarks are deep in the red for 2011. In the meantime, the Dow Jones Industrial Average (INDEXDJX:.DJI) managed to eke out some gains for the year, a feat given all circumstances.

 

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Investors wonder how was that possible?

It has to do a lot with what investors think of the outlook for the U.S. economy. Despite major problems such as record government deficits,  high unemployment, a soft housing market  and slow economic growth, investors like to see the glass half full rather than half empty.

Latest numbers suggest consumer sentiment is improving as is evidenced by a record Holiday spending. Given that consumer spending is responsible for two thirds of GDP growth, it is a vital barometer in assessing the state of the economy. And while there is a lot of room left for improvement in the job market, there are signs that the nation is better off at the end of the year than it was in January a year ago. The housing market is still soft, but dynamics suggest that the tide may change sooner than later. The number of foreclosures is down and there are signs that those homes will eventually clear from the pipeline. Once that’s done, new homes will lift prices and help start a recovery in the housing sector.

We are fully aware that the glass is just half full. All these optimistic calculations may turn upside down should Europe plunge into a serious recession.

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China’s official GDP growth for the year is still in the works but most analysts predict it to be close to 9.8%. Considering that a 10.3% GDP growth in 2010 and a 9.8% in 2011 resulted in a combined drop of 32% for the Shanghai Composite Index (SHA:000001) and a 15.7% decline for the Hang Seng  Index (INDEXHANGSENG:.HSI), Chinese stocks remain undervalued. Sure, China’s GDP growth is falling along with manufacturing growth as exports to Europe plunged, China’s largest trading partner. China’s housing bubble is another problem while inflation remains relatively high. Nevertheless China is well situated to continue to benefit from a relatively cheap currency, an inviting economic climate and a fast growling domestic market.

Many may have not noticed that the U.S. quietly dropped labeling China a “currency manipulator” in December. Looking at the following chart, it is obvious that that the Chinese Yuan appreciated again the U.S. dollar by almost 25% in the last five years while the Euro is basically back to zero after a volatile ride during the same time. This implies Beijing is “listening” to the U.S. and is not in a position to sever ties with its second largest trading partner.

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This is good news for investors for despite all the rhetoric, China and the U.S. are working out differences in a rational manner.

We all know that timing is key when it comes to successful investing. With China stocks hitting over 2 year lows in both key Asian markets, an increasing number of investors see an opportunity. It boils down to risk tolerance at this point for high returns require high risk. To enter the market now may seem risky but brings a potential of entering the market at the bottom. Or not…

The following chart to the right highlights the risk China stock investors were facing in the past year. The first chart lists the best 20 Chinese stocks listed in the U.S. It is hard to miss that almost half of the best performers are still in the red for 2011!  Only a handful of stocks managed to eke out gains or gave investors a sound return.

Looking at the biggest losers for 2011, the list is not only long and steady but the numbers are horrifying. The combined return of the 20 worst Chinese stocks in 2011 is a negative 79.7 percent! While the Chinese solar sector is particularly hit hard, there are stocks from all over the board.

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The good news is that quality stock selection made a significant difference in 2011, again.

Chinavestor portfolios comprised of Melco Crown Entertainment (NASDAQ:MPEL), China Unicom (NYSE:CHU), NetEase.com Inc. (NASDAQ:NTES) and Baidu.com Inc. (NASDAQ:BIDU) on numerous occasions. These stocks were the best four stocks in 2011! Altogether we not only picked the best ones but we picked a lot of them. We picked fifteen out of the best 20 stocks for the Conservative and Growth portfolios, enabling subscribers to stay ahead the game. And while we identified stocks that outperform, we also avoided those that burned investors.  Out of the worst 20 stocks, we only picked Vanceinfo Technologies (NYSE:VIT) at the beginning of the year and pulled the plug on it after three months, saving investors from most of the plunge.

Going forward, visibility is still low but again, this creates opportunity for the intelligent investor.

We continue to like the technology sector on fundamentals. China’s internet population most likely surpassed 500 million by the end of 2011 adding 25 million new users every six months. China’s premier online portals, search engine and online gamers are full of cash, have practically no debt and continue to grow at a fast pace. Baidu.com Inc. (NASDAQ:BIDU), China’s largest search engine, is not only benefitting from organic growth but has managed to chip away market share from other players, including Google Inc. (NASDAQ:GOOG).

Sina Corp. (NASDAQ:SINA) is also an important player in China. While the stock fell over 50% in the last six months of 2011 on its Twitter like “Weibo” associated costs, the stock is a bargain at current prices in our opinion.

NetEase.com Inc. (NASDAQ:NTES), the most profitable Chinese online game developer and operator, is another stock of interest.  We continue to like the stock for its market position and strong balance sheet.

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 Another sector we continue to hold position in is the services. This is the only sector in fact that managed to deliver some gains for investors in 2011. Most of the gains are attributed to Chinese telecommunication stocks, and to China Unicom (NYSE:CHU) in particular. The stock delivered close to a 50% return just like Melco Crown Entertainment (NASDAQ:MPEL) did. China Telecom (NYSE:CHA), China’s largest fixed line telephone operator, advanced 9.3%, a superb performance given overall market weakness.

But investors have to exercise caution going forward for money flows don’t seem to be  supporting much upside for the next quarter.

A detailed money flow chart is available for each and every sector at the end of this Newsletter!

Energy and utility stocks continue to play a vital role in Chinavestor portfolios. Both sectors outperformed the broad market in 2011 and we expect them to do similarly in 2012. The trick is to find the right stocks at the right  time among Chinese integrated oil companies for their characteristics are distinct. Petrochina Co. Ltd. (NYSE:PTR) is best when price of oil is high. This company is China’s largest oil producer with a significant refining operation among others.

But Sinopec (NYSE:SNP) is adversely effected by high oil prices for its refining margins are off when price of oil rises. This company is the largest refiner in all of Asia and thus is sensitive to oil price swings.

We had Mindray Medical (NYSE:MR) from the healthcare sector in the portfolios from time to time to the benefit of our investors. Chinese transportation stocks continue to suffer but Seaspan Corp. (NYSE:SSW) has enjoyed very strong money flows and is expected to outperform the market for the near future.

I will remain accessible for clients in 2012. Wish you successful investing,

Blaze Fabry.

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