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Europe, earnings, fraud pressure Chinese stocks

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decline August 2012 (Chinavestor) Europe continued to play a central role in the performance of equities globally in July, just as we predicted. Not only did the ongoing European sovereign debt crisis push the old continent into a recession but its largest trading partners, China and the U.S., are feeling a pinch as well. The United States has its own set of problems, stemming from a soft housing market at best, sluggish jobs market and uncertain manufacturing activity, not to mention high government debt and mixed consumer confidence.

Chinese investors main problems are twofold at the moment. The economy is showing clear signs of a slowdown while corporate earnings crumbled in key sectors. China’s manufacturing PMI declined to 50.1% in July, just above the psychologically important 50% level. Second quarter GDP growth slowed down to 7.4% as well. Investors hoping for a monetary easing were dismayed to find out that policy makers have no intention to loosen such policies in fear of accelerating inflation and higher housing prices. Baoshan Iron & Steel (SHA:600019), the largest steel maker in China, reported net income drop of 86% from a year earlier, highlighting pressures on the basic material sector. China’s retail giants and once mighty internet companies reported falling net income as well.

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But investors in the U.S. had a reason to cheer for the Dow Jones Industrial Average (INDEXDJX:.DJI) rose 1.0% for the month and is up 6.5% YTD! Investors found some solace in Greece’s election results and ECB President Mr. Draghi’s comments that the European Central Bank will do whatever it takes to preserve the common currency. This includes now buying Spanish and Italian bonds, a new area for the bank that used to be responsible for price stability, e.g. fighting inflation, only.

Chinese stocks in Hong Kong took clues from western markets, sending the Hang Seng Index (INDEXHANGSAENG:.HSI) 1.8% higher for the month. The China ADR Index, measuring the performance of Chinese stocks listed in the U.S., traded sideways for the month.

Despite a relatively good performance of western markets, Europe fell into a recession with no end in sight of the negative cycle. Retail sales and consumption loans, key drivers of western economies, continue to fall as consumers are not spending in a fear of what tomorrow may bring. This bodes ill for the U.S. and China as well, dampening hopes of a quick recovery in those regions.

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Despite a hostile market environment, selected Chinese sectors did very well in July. Transportation stocks, particularly airliners, outperformed the broad market following news that policy makers will ease the tax burden of the sector and will pump liquidity into ailing airliners to make them more competitive. China Eastern Airlines (NYSE:CEA) rose 8.5% while larger rival China Southern Airlines (NYSE:ZNH) surged 12.0%.

Chinese telecom stocks soared as bargain hunters picked up major carriers in July. China Unicom (NYSE:CHU), the second largest mobile carrier in China, surged as much as 16.4% for the month while China Telecom (NYSE:CHA) jumped as much as 18.2%! Industry giant China Mobile (NYSE:CHL) rose 6.3% to $58.12, a level not seen since 2008.

Consumer stocks, particularly consumer durables, rose sharply in July thanks to a sound performance from Zhongpin Inc. (NASDAQ:HOGS) and Synutra International (NASDAQ:SYUT).

Financial heavy weight China Life Insurance (NYSE:LFC) rose 4.4%, moving the rest of the sector with it.

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Technology stocks were mixed with solar stocks weighing down the rest. Trina Solar (NYSE:TSL) warned of significantly lower revenues while Suntech Power (NYSE:STP) announced it fell victim to a fraud, potentially costing it $680 million. No wonder, industry leader Yingli Green Energy (NYSE:YGE) sank 42.2% along the rest of the sector. The stock hit an all time low of $1.60 at the end of July. Altogether the solar sector fell 25.2% on average for the month.

Internet stocks were mixed with industry leader Baidu.com Inc. (NASDAQ:BIDU) advancing 4.8% while most larger tech stocks experienced a free fall. And just how wide the sell-off was, investors have to consider this: seven out of the ten largest tech stocks fell over 10% in July. And these are not counting solar stocks, a sector whose market cap has shrinked considerably since its peak in late 2007.

Basic material stocks fell the hardest among major industries in July as the chart above testifies. Aluminum Crop. of China (NYSE:ACH), the third largest maker of the metal in the world, fell 6.1%, dragging down the sector performance. Huaneng Power International (NYSE:HNP) was primarily responsible for the weak performance of utilities for the month.

Let’s just revisit the Chinese solar sector for a moment. When investors thought the worst was over for the sector at the end of 2011, things went from bad to worse. We published the first chart of this page at the end of 2011 to highlight the perils Chinese investors face. After a couple of sound comebacks at the beginning of 2021, the sector took a sharp downturn with no end in sight as we speak. Bargain hunters may consider current low prices as cheap entry points, an argument that might be valid. But investors have to have a strong stomach and good timing to make money off the sector for the short term.

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There is little argument that ultimately fundamentals determine stock prices, but even that might bring in surprises. Think of earnings from Ctrip.com International (NASDAQ:CTRP), the once mighty online travel agency. The company disappointed for the current quarter, reporting net income of a mere $19 million, down 55% YoY. What’s more troubling for me is that the company booked “stock based compensation expense” of $17 million, almost 50% of all non-GAAP disposable income to shareholders.

Finally, we have to speak a few words about New Oriental Education and Technology(NYSE:EDU), the industry leader in the education space. Muddy Waters, a whistle blower company that brought down once mighty Sino Forest in Toronto and Rino International on the NASDAQ, alleged EDU of overstating its sales and net income numbers. The effect was disastrous for New Oriental shareholders and to China stock investors at large. EDU makes it the third Chinese company from the education sphere to fall victim to such allegations after China Education Alliance (NYSE:CEU) and ChinaCast Education (NASDAQ:CAST) got booted from the big boards. Investors are facing increasing headwinds from Chinese stocks, a trend that only quality earnings can turn around. We’re going to have more visibility after more Chinese companies report earnings in August. Till then wish you successful investing,

Blaze Fabry



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