July turned out to be the best month of 2009 for investors globally putting Chinese and American indices in high gear. The Shanghai Composite Index advanced 15.3% in July alone, the best monthly gain in over two years. July marked the seventh straight month of gains sending the index up 87.4% year-to-date (YTD).
Another important Chinese benchmark, the Hang Seng Index from Hong Kong, advanced 11.9% in July, making the month of July the third best month in 2009 so far.
But American investors had no reason to be upset either, the DJIA gained 8.6% in the month of July, the best July in 20 years and the best month since October 2002.
The index for Chinese companies listed in America, the China ADR Index, was relatively weak but advanced 4.7% in July. The index is cap weighted where China Mobile (NYSE:CHL) is an index heavy weight and underperformed most large cap Chinese companies.
Most of the gains in July came at the second part of the month, as earnings and improved outlook started to take an effect. Macroeconomic data suggests that the longest recession since WWII is losing its grip, fueling investors’ optimism.
Besides favorable American and world economic sentiment, Chinese shares got an additional boost from Chinese macroeconomic data. Manufacturing activity expanded for the fifth straight month, lending climbed to a record, property prices and activity surged, retail sales improved and all major investment houses upped their outlook for China’s GDP growth.
Regarding stock market performance, the Shanghai Composite Index is high powered by the resurgence of retail investor activity. According to the latest statistical figures, the number of new individual investor accounts surged to a record in July, plowing hot money into the stock market..
Now the questions are at least twofold: how long the rally will last, and how to best capitalize on the rally?
We have always argued that one of the safest ways to play China is via ETFs. They eliminate company specific risk yet don’t limit upside potential.
According to the Overbought/Oversold indicator, the Morgan Stanley China (NYSE:CAF) is well below its underlying index, the Shanghai Composite.
Likewise, the iShares FTSE/Xinhua 25 Index (NYSE:FXI) is somewhat below both the Hang Seng and the China ADR Index.
This in turn suggests that both ETFs locked in unrealized returns, and as long as the rally lasts, both ETFs are expected to at least catch up with their corresponding indices. In this case it means an additional 10% gain for the Morgan Stanley China (NYSE:CAF) and a 2%-3% gain for the iShares FTSE/Xinhua 25 Index (NYSE:FXI).
Interestingly, the Hang Seng Index is more overbought at the moment than the Shanghai Composite, a fact that is explained by the strong gains in the Hang Seng Index during the last two weeks.
Despite a strong overbought showing for both Chinese indices, we remain bullish for the short term. Assuming that earnings will come in just in line, there is a major factor that is driving Chinese stocks higher: ample liquidity. Chinese regulators eased lending, a key of the Yuan $4 trillion ($586 billion) stimulus package unveiled in last November. As I mentioned earlier, the number of new retail accounts are surging as ordinary Chinese are betting on the success of recovery. According to the latest statistics, individual investors opened just shy of 500,000 accounts in a week in July, five times the volume of January.
With abundant liquidity in China, market regulators have agreed to the resumption of IPO activity, launching the biggest IPOs of the year. China State Construction Engineering Corp., the largest home builder in China, raised a record $7.3 billion in July. High demand on the first day of trading raised the market capitalization of the company over that of the entire Russian or Norwegian listed companies.
With earnings season on, corporate earnings will play a vital role in setting stock prices. So far there have been five Chinese companies reporting second quarter earnings in July, with mixed results.
Baidu.com (NASDAQ:BIDU) and China BAK Battery (NASDAQ:CBAK) reported better then expected, but earnings of Sohu.com (NASDAQ:SOHU) and Changyou.com (CYOU) were below analysts’ expectations. The weak showing of Changyou.com took a toll at the entire online game sector, sending shares of Shanda Interactive (NASDAQ:SNDA) tumbling 20% from record highs.
Semiconductor Manufacturing (NYSE:SMI) tumbled over 7% following a weak showing while AsiaInfo (NASDAQ:ASIA) jumped on strong revenue increase.
Looking ahead I expect strong performances from NetEase Inc. (NASDAQ:NTES) and Ctrip (NASDAQ:CTRP) of the NASDAQ listed China stock universe.
Looking at NYSE listed Chinese stocks, strong metal prices helped earnings and third quarter outlook for Aluminum Corp. of China (NYSE:ACH). The Company issued a statement on July 27 that it sees a loss for the first six months of 2009. But given that it was deep in the red for the first three months, the combined six months loss may be less than expected. So far it looks as if the markets are expecting a turn around soon, based on the significant jump on July 27, following the announcement.
I expect strong numbers from Sinopec (NYSE:SNP) and the rest of the Chinese oil sector. Sinopec will outperform its peers in earnings thanks to lower crude prices and improved margins, but outlook for the company is not as bright going ahead for the rest of the year. Petrochina (NYSE:PTR) looks good before earnings with additional boosts coming from Shanghai, where the stock is a super heavy weight of the Shanghai Composite, attracting a large amount of money flows.
Chinese airliners have been on fire in July thanks to strong numbers from Air China (HKG:0753), the Chinese flagship carrier. Passenger numbers are up and with lower fuel costs, airliners are looking good ahead of the earnings. The downside is that China Eastern Airlines (NYSE:CEA) and China Southern Airlines (NYSE:ZNH) have rallied 43.0% and 28.4% in July, respectively, capping upside potential to next to zero.
Another company that I expect to offer trading opportunity is Huaneng Power (NYSE:HNP). The company is expected to report second quarter earnings between August 7-11 and I think it will be a very positive surprise. Energy demand turned high in the second quarter while rates have improved, a combination that may result in an explosive earnings growth for the company.
The Chinese telecom sector has been underperforming lately, something that seasoned investors pay attention to. China Mobile (:NYSECHL) applied for approval to a Shanghai listing, a move that is likely to manifest in 2009 and could bring in strong money flows for the stock.
China Life Insurance (NYSE:LFC) is expected to report strong earnings, but that is already incorporated in its stock price.
PS I: September Newsletter will be posted on the website on September 1st.
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