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Earnings season hurts China tech stocks

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cash_4 May, 2012 (Chinavestor) April of 2011 was the month of consolidation for Chinese stocks world wide. Hong Kong’s main gauge, the Hang Seng Index (INDEXHANGSENG:.HSI), leveled off after a spectacular run in January and February. The index advanced a mere 0.9 percent for the month but is still ahead 14.4 percent for the year. Stocks on the mainland continued to advance in April, rising the broad Shanghai Composite Index (SHA:000001) 5.9% for the month. The index is up 9.0% year-to-date (YTD), the best first four months performance in three years. Most of the gain is attributed to anticipation that the Chinese government will lower the bank reserve ratio sooner than later. But let’s just skip this topic for the moment because we will come back to this in the second part of the Newsletter. The index measuring the performance of Chinese stocks listed in the U.S., the China ADR Index, shed –0.9 percent in April due to weakness in the consumer and tech sectors. The index is up 7.4 percent YTD, underperforming key Chinese indexes in Asia as well as the Dow. The Dow Jones Industrial Average (INDEXDJX:.DJI) itself managed to eke out a 0.01 percent gain for the month, advancing for the seventh month in a row. That seven month winning streak is the longest since 2007!

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The reason for such a rally is the overall feeling that the U.S. economy is in better shape than originally thought a year ago. Consumer confidence is rising, lifting hopes that spending will continue to keep the world’s largest economy moving. Remember, consumer spending is responsible for two thirds of GDP growth in the U.S.

Investors turned cautiously bullish in China as well following news that inflation, the hallmark headache for policy makers, continued to tame and stayed under the “acceptable” 4 percent level in March. Even better core inflation, e.g. consumer price index ex food items, fell fellow 3 percent, making room for policy makers to ease fiscal policy. For dynamics of inflation in China, take a look at the chart below.

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A loosening fiscal environment is accommodating at a time when fears of a hard landing were a reality. Consumer stocks took a beating in April as the second chart on this page testifies, after fears rattled markets that consumers will cut back on spending in harder economic times. Consumer cyclical and consumer durable stocks fell the most in April along with technology stocks. Weakness in the tech sector is attributed to disappointing earnings, something we will get back in the final chapter of this Newsletter.

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But latest statistics point to a much softer landing than many feared while inflation remains at check. This prompted speculation that Chinese policy makers will lift bank reserve ratios more aggressively, pumping currently restrained liquidity into the economy. Considering that European woes still persist, see latest round of downgrade of Spanish banks, China needs domestic consumption to pick up the slack. Remember, the European Union is the largest trading partner of China ahead of the United States. Investors are looking forward to a massive public housing initiative that will kick into high gear in the second part of this year.

Besides changes in the macro environment, corporate earnings moved stocks in April. The Chinese corporate calendar has been historically lagging the U.S. by a month. The majority of large cap Chinese companies, most of them NYSE listed, report in April while the majority of NASDAQ listed Chinese companies do it a month later. Some highly visible Chinese tech companies report in April, setting a tone for the rest in May. And so far that has been a drag on Chinese stocks.

Baidu.com Inc. (NASDAQ:BIDU), a Chinavestor favorite for a long time, fell to $130 after reporting first quarter numbers, weighing down the rest of the sector. We argued and continue to believe that Baidu’s numbers were a lot better than what the Street thought . Apple Inc. (NASDAQ:AAPL) reported at just about the same time and rallied despite a shrinking top line and bottom line. We think the markets are a lot more forgiving to Apple Inc. (NASDAQ:AAPL) than for Baidu.com Inc. (NASDAQ:BIDU). Another prominent internet company, Sohu.com Inc. (NASDAQ:SOHU), reported in April to the dismay of investors. While revenue growth was mostly in-line with expectations, net income growth or rather lack of it, poses a challenge to the stock. And this is for a good reason because we believe that earnings ultimately drive stock prices. Considering Sohu’s weak 2012 Q2 net income outlook, we are bearish of the stock for the next three months.

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Despite a disappointing start from the tech sector, investors had a good reason to cheer in April. Large oil majors did well thanks to high oil prices and sound oil output. Petrochina Co. Ltd. (NYSE:PTR) and CNOOC Ltd. (NYSE:CEO) are up for the month and are expected to do well as long as oil stays above $100 a barrel.

Chinese airliners recovered somewhat from 6 month lows in mid April as investors digested latest numbers. Overall growth for the industry slowed to around 5%, hurting outlook for the rest of the year. High oil prices dented into net profits as well, a combination of factors that slashed profitability for the sector. But we see a lot of potential going forward based on valuation and long-term growth. The same argument goes for the Chinese solar sector, a highly volatile sector that is trading at low valuation at the present.

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Finally, investors got a chance to look into China’s telecom market in April after all three major telecoms reported quarterly figures. There was a lot of noise out there but we picked up a piece of information that we think is highly valuable. China Unicom (NYSE:CHU) added more smart phone users to its network in the first quarter than industry giant China Mobile (NYSE:CHL). A shift in dynamics is evident by taking a closer look at China Unicom’s feature phone (2G) segment and smart phone segment (3G). The company added less than one million 2G subscribers for the first three months of 2012 compared to a 8.84 million addition to its 3G segment. Considering that smart phone users are future profit drivers simply because they spend a lot more money per month than feature phone users, China Unicom (NYSE:CHU) is well positioned to keep its profits growing. Lack of net income growth continues to hurt China Mobile (NYSE:CHL), a stock that fell 3.5% the day it announced earnings vs. China Unicom’s 5.6% surge. This explains why we are bullish on China Unicom (NYSE:CHU) and less enthusiastic about China Mobile (NYSE:CHL).

Wish you successful investing, Blaze Fabry.



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