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January 2009 Newsletter: Thank God, 2008 is over.

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2008 will not be the year many of us will want to remember. Global financial crisis wiped out wealth worth trillions of dollars; stocks, commodities, savings all suffered. There are plenty of lessons to be learned of which some will make it to history.

Looking at the broad landscape, Chinese indices world wide took a beating in 2008. As the following chart depicts the Shanghai Composite suffered the most, giving up 65.8%. Chinese stocks listed in Hong Kong and in America, measured by the broad Hang Seng index and the China ADR index, lost 46.5% and 45.4%, respectively. Compared to these horrific performances the -32.8% return of the DJIA looks favorable. There is plenty of reason to be discouraged. But us, investors, will have to set our mind for the upcoming year and find opportunities that lie ahead of us.


The first sign that change is on the horizon presents itself right on the same chart. While the DJIA continued to slide all Chinese indices, most notably the China ADR index, have recovered since November. This recovery may be regarded as a technical bounce back but I’m of the view that this is more a result of a fundamental change than anything else. I attribute this recovery most of all to the Chinese stimulus package of $586 billion announced in early November. And while investors in Shanghai got excited early on believing that the government can help turn things around, their enthusiasm faded away in December; measured by the weak performance of the Shanghai Composite. To the contrary, western fund managers took a cautious approach and started to buy Chinese equities once they thought the stimulus package have a chance to stimulate the economy. This explains why the China ADR index was slow to respond in November but came off strong in December.

To get an idea what to expect from 2009 we have to assess the global situation and China itself. Even though they correlate there are notable differences.

The global situation is all but clear. We know that the U.S. holds the key but it doesn’t get us closer to the solution. The situation in the U.S. is still fragile with no clear indication what 2009 will bring. I want to highlight a few indicators that are instrumental:


· Consumer confidence is key to GDP growth. Since this measure just hit a 26 year low in late December, this is bad news on the big scale.

· Housing prices continue to drop. Since real estate is the single biggest asset average individuals have, spending will be slow until this situation improves.

· The good news is that commodity prices, most notable oil prices, experienced an unprecedented drop in value since June 2008. This leaves valuable disposable income in pockets helping to pay for mortgages or just increase spending in general.

· Inflationary pressure is low leaving maneuvering room for fiscal stimulus packages.

Overall the economic picture is dim with no clear indication neither for improvement nor for a downturn in the United States.

The situation is different in China though. But many investors don’t get to see it. They tend to rush in near the top and flea the market near the bottom.  For those who stay in China for the long haul, here is some news to digest.

China announced a stimulus package of Yuan 4 trillion or $586 billion. Since most of the funds will come from local provinces, effects of the stimuli will not be visible until the second half of 2009. In the meantime the State Council, equivalent of the Cabinet at home, stepped in to keep China’s economy chugging.

· They approved sweetened tax rebates, effective January 1 2009,  to help exporters of electronics and machinery.

· They decided to buy large quantities of aluminum to support product prices.

· They changed regulations for insurers allowing them to invest directly into infrastructure, a move seen many as a great tool to unleash $48 billion of assets sitting on the books of China’s insurers.

· They continued filling up strategic supplies of oil at its largest reserve taking advantage of historical low crude prices.

There is no way to know if these measures will be able to keep the world’s fourth largest economy growing at 8% as state officials targeted, but one thing is for sure; China looks prepared and is taking action to withstand the worst of the crisis.

Assuming that China will get over the crisis in a relative good shape, the question remains how to benefit from it.

First and foremost, investors have to hold positions right at the bottom. As previous studies show Chinese ADRs are 2.5 times more volatile than their US counterparts. In other words when the DJIA sheds 10%, Chinese equities lose 25%. But the same is true when recovery kicks in. When the DJIA gains 10% Chinese equities will rally over 25%. So if you wait to see a steady recovery you will have already missed the train.

The second advice I have is that when a stock shoots up too much too fast, take profits off the table and don’t get greedy. This is a case with Aluminum Corp. of China, or Chalco, (ACH) and some stocks from the solar sector.

We have long argued that  Chalco is undervalued and thus presents excellent trading opportunity under $10. If you took our advice and built entry position, you were more than rewarded when the stock shoot over $15 in middle of December and stayed there for a few days. If you read your Overbought/Oversold indicator commentary and acted on our notice, you made some hefty gains. We’re still bullish on Chalco for the long run but remember that Chinese stocks are extremely volatile and long term gains doesn’t mean a straight line up.


Another example for such gains is oversold ADRs from the Chinese solar industry. Trina Solar (TSL) and JA Solar (JASO) rallied 30% on December 30, a technical recovery on stronger oil prices and a horrible YTD performance. If you hold positions in any of those companies you better short those stock and lock in profits.

Another key for a successful investing for the first half of the upcoming year is to find oversold value stocks. To zero in on such stocks, take a look at the following charts on the right. We have calculated a cap weighted index for NYSE listed China ADRs or CYI and one for the NASDAQ listed China ADR universe or CQI. Then we kept track of consequent P/E ratios and charted their performance over the course of 2008.


The first and foremost important result we find is that while NASDAQ listed Chinese ADRs have historically been trading at a much higher P/E ratio, 2008 marks the end of the area. At the beginning of 2008 average P/E for NYSE listed China ADRs stood at 21.9 while the same reading was 58.6 for their NASDAQ counterparts. By the end of the year NASDAQ listed Chinese ADRs were trading at 7.74 times earnings, a discount compared to their NYSE counterparts.


This dramatic change is attributed to a few larger cap NASDAQ listed China ADRs such as (BIDU), (CTRP), (SOHU) and Sina Corp. (SINA). The most remarkable stock is whose once mighty P/E of 181.3  dropped to 31.7 times earnings by the end of 2008. But markets punished travel industry specialist as well sinking its P/E from 85.5 in January to 24.4 by the end of December. took a serious blow as well as her PE fell from 77.2 to 15.4 during the last 12 months.

But remember, a low P/E doesn’t necessarily mean that a stock is a buy. (BIDU) suffered a serious blow in the middle of November on allegations that her business model of selling links deluges its effectiveness and seriously undermines its search results. This is a serious fundamental challenge and recovery will take time. Inc. is trading at a modest valuation because it delivered robust earnings and not because its price dropped. Moreover the Company announced share buyback and issued 2008 Q4 revenue target above analyst expectations. In essence while BIDU got hit fundamentally, SOHU delivered robust results during which time its stock price sunk. From this respect SOHU is the gem.

To find stocks that are oversold we listed the forty three most liquid Chinese ADRs based on their performance since the market peak of October 2007. Only one Chinese ADR is above the water, (NTES) is up 9.2% while all other stocks took a beating.  


Change since the market peak of October 2007


And while Chinese solar stocks are serious underperformers their profitability is in serious jeopardy following low oil prices and overcapacity.

The Chinese airline sector is  badly hurt with problems such as too much regulation and lack of cash. But when the dust settles both CEA and ZNH have big upside potential in my opinion.

The Chinese energy sector is tricky but Huaneng Power (HNP) is a potential good buy right at the bottom following  2008 H2 announcement. Coal prices fell 60% in the last three months helping power generators returning to profitability.

Chinese telecom sector offers two stocks with positive outlook; China Telecom (CHA) and China Mobile (CHL).

Sinopec (SNP) is a beneficiary of low oil prices so keep your eyes open for entry positions.

Wish you successful investing in 2009!

Blaze Fabry

Major indices in 2008


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