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How to play China stocks in October?

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play_1(October 1, 2009 - Chinavestor) Despite fears that September has been historically a weak month, the DJIA continued the recovery and advanced 2.3% for the month. Looking out for the quarter, the DJIA gained 14.98% since July, making it the best quarterly performance for over ten years. Thanks to the strong showing of the DJIA in the last quarter, the index has been closing in on Chinese indices such as the Hang Seng and the Shanghai Composite.

But China stocks investors have no reason to complain either. While the Shanghai Composite index has given up almost 20% since its peak in early August, the index is still up over 50% for the year. And while the 20% correction makes investors cautious, the overall picture is not as bleak as the chart would suggest. China’s index started to rally in November 2008 after the government announced a Yuan 4 trillion stimulus package. Lending was cut loose and liquidity drove the index up 90% by August 4. But a correction came as policy makers signaled that the time has come to return to fiscal discipline.

As the number of retail investors swelled in Shanghai, herd behavior started to influence trading. When news broke out that the CEO of Hong Kong’s second largest bank sold a significant amount of bank shares earlier in September, investors shunned financial stocks sending the Shanghai Composite tumbling.

Despite current weakness in China’s domestic bourse, the latest economic data suggests the Chinese economy is standing on a strong footing. Manufacturing activity remained strong and rose for the sixth straight month in September, despite weak export data. This in turn means that Chinese domestic consumption is making up for the loss of exports, a sign that China as a market is maturing and is less reliant on the world economy. It is important to take note that China surpassed the U.S. not just as the largest auto manufacturer but the largest market as well. Part of this dramatic change is a result of the stimulus program introduced by the Chinese government. Auto sales rose by 90% in August 2009 from a year ago in China, while American auto markets are just coming off the worst drop in sales in the last decade.

We remain optimistic about the outlook for the market in Shanghai for the rest of the year. A correction by August 2009 was timely though the magnitude came as a surprise. But again, considering the large number of individual investors, extreme volatility shouldn't have been such a big surprise. Our target for the Shanghai Composite for December 2009 is somewhere between 3,000—3,200.

This will translate to a $36 a share or more for the Morgan Stanley China ETF (NYSE:CAF); the China ETF that is tracking the performance of the Shanghai Composite index the closest.

China stocks continued to shine in Hong Kong, making a case for ETFs tracking  the performance of the Hang Seng Index. The iShares FTSE/Xinhua 25 Index (NYSE:FXI) has been an excellent tool to yield returns similar to the Hang Seng Index.

We know that the Chinese shares tend to be two and a half times more volatile then their American counterparts. This makes investors smile in a bull market, but be careful because China stocks fall more than twice as fast then American ones when the bears return.

When it comes to China, American investors have a wide range of stocks besides ETFs. The number of Chinese companies listing on the NASDAQ is on a steady rise, giving investors a wide range of options. The number of NYSE listed China stocks is fairly constant. But the big difference is in the trading characteristics of China stocks listed on the NASDAQ vs. the NYSE. As the nearby chart on this page demonstrates, NASDAQ listed China ADRs substantially outperformed their NYSE counterparts in 2009 so far.


The reason for such a wide gap between the two is explained by the fact that while the largest NASDAQ listed  China ADRs have been on fire this year, the largest NYSE stocks lost their mojo.

Take a look at (NASDAQ:BIDU) for starters. This company is the single largest NASDAQ listed China stock when it comes to market capitalization. The stock is up 199.24% YTD and is fighting the $400 resistance level.

Another prominent China NASDAQ play is (NASDAQ:CTRP). We have just issued a sell signal for Chinavestor subscribers on September 29 after the stock hit $60, a 100% return since we introduced (NASDAQ:CTRP) into the Growth portfolio. has a market capitalization of almost $4 billion, making it the third largest China play after (NASDAQ:BIDU) and (NASDAQ:NTES). is the most profitable Chinese online game developer and operator with a market cap of $5.9 billion—and a staggering 100% yield YTD.

This is in sharp contrast to the performance of China Mobile (NYSE:CHL) and Petrochina (NYSE:PTR), the largest NYSE listed China plays.

As the following chart suggest, China Mobile (NYSE:CHL) has been way underperforming not only the Hang Seng Index but the rest of the sector in 2009. But this creates an opportunity for the value investor when China Mobile is trading at a 12 P/E ratio. China Mobile (NYSE:CHL) is not only the largest mobile carrier in the world by subscriber base, but generates strong cash flows and is still the fastest growing Chinese carrier. The reason why this blue chip has been under the water is her slow 3G penetration due to network protocol problems. After the 3G fallout at the end of last year, China Mobile (NYSE:CHL) got stuck with a home grown TD-SCDMA network protocol. Chinese regulators are hoping to make this Chinese developed standard a success at home, eliminating expensive fees associated with both CDMA and GSM network protocols. The problem is that no major phone maker has come forward with a phone that can roll over current GSM subscribers and deliver 3G features, all in the same phone. This in return hinders 3G growth for China Mobile (CHL), and this is where the stock price is hurt. But don’t expect this situation to remain unsustainable for too long. Industry heavy weights such as Nokia are now scrambling to develop such a phone for China Mobile (NYSE:CHL) running on Google’s Android platform. When that phone hits the market, it not only will be sought after but will be cheap thanks to the Android platform. This is when the share price of China Mobile (NYSE:CHL) will show its worth  - but the time is now for share accumulation.


Another sector that is worth paying attention to is the Chinese online game segment. While this is a small segment in America, China is a different ballgame. Nintendo, Sony and Microsoft don’t sell games in china due to rampant piracy. Instead, companies have developed games that are hosted in massive servers and are accessible via the internet. Players pay as they go, paying for the time they spend playing the game. The result is that this segment of the internet has become the largest revenue generator surpassing total revenues from advertizing or search in China.


So when Shanda interactive Entertainment (NASDAQ:SNDA) spun-off her game unit under the Shanda Game Ltd. (NASDAQ:GAME) name, the IPO brought in over $1 billion. Remember, this IPO was just a copy of what (NASDAQ:SOHU) did with her online game unit, Changyou is now a NASDAQ listed entity trading under ticker CYOU and has become the profit center for Sohu. Both Shanda Interactive (NASDAQ:SNDA) and (NASDAQ:SOHU) retained the majority of the IPO allocation for themselves, effectively consolidating profits of the game units into their own financial statements as well. So if you had a question about what has remained of Shanda after is spun off her game unit, the answer lies in the large portion of retained GAME shares.

Investors should take a very close look  at the chart on this page. This runs a comparison between (NYSE:CYOU) and (NASDAQ:SOHU) after the IPO. As the chart demonstrates, the core assets of have underperformed compared to the profitability of

If history can be a guide in predicating future performance, swapping Shanda Interactive Entertainment (NASDAQ:SNDA) shares to Shanda Game Limited(NASDAQ:GAME) makes perfect sense.

And one more advice for October. We know that NASDAQ listed Chinese ADRs have been on fire and way outperformed their NYSE counterparts. This is holy grail when markets head north. But if October turns to be a bearish month, NASDAQ listed China stocks will experience a hard landing, especially the more volatile smaller names. So if you made profits in the last quarter and are exposed to NASDAQ names, the time has come to take profits off the table.

Wish you profitable investing. Blaze Fabry

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