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April 2010 Newsletter: World markets rally at the end of March—will it last?

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questionmark Looking back to March 2010, U.S. equity investors have a lot to celebrate. Not only has the DJIA advanced for the fifth straight month, latest economic data suggests more is on the way. Strong U.S. manufacturing data, a reading not seen in six years, combined with the best monthly jobs report in three years suggests the world's largest economy is on track for a sustained recovery. Investors' optimism is evident by looking at the performance of major U.S . indices for the month or year-to-date (YTD). The DJIA, S&P 500 and the NASDAQ closed at new 52-week highs at the end of the March. However Chinese indices remained in the red for the year despite a significant rally at the end of March.


Stocks, ETFs and indices mentioned in this report include Inc. (NASDAQ:NTES), China Life Ins. (NYSE:LFC), Shanda Int. (NASDAQ:SNDA), JA Solar (NASDAQ:JASO), Canadian Solar (NASDAQ:CSIQ), LDK Solar (NYSE:LDK), Suntech Power (NYSE:STP), Yanzhou Coal (NYSE:YZC), Petrochina (NYSE:PTR), CNOOC Ltd. (NYSE:CEO), Sinopec (NYSE:SNP), E-House Hold. (NYSE:EJ),  Shanghai Composite Index (SHA:000001), DJIA (INDEXDJX:.DJI), iShares FTSE/Xinhua 25 Index ETF (NYSE:FXI), Industrial and Commercial Bank of China (SHA:601398), Bank of China (SHA:601988).

Most of China's problems are stemming from uncertainty surrounding the stimulus exit. Now that the Chinese economy is growing over 10% again, as the first quarter data suggested, fears of asset price bubbles, credit tightening and accelerating inflation are on the rise.

The rise of inflation, real or anticipated, is a potential threat to growth. Savings rate in China is one of the highest in the world with most savings sitting in the banks. If inflation picks up, individuals diversify away from bank savings unless interest rates rise. Any diversification would go to real estate, an already hot market, further increasing the chance of forming asset price bubbles. To prevent this, interest rates must increase, but with higher interest comes higher borrowing costs, thus hurting economic growth.

A new development for March is the first Chinese monthly trade deficit in 17 years. It's too early to tell if the first monthly trade deficit for China is a beginning of a structural change or not but one thing is for sure: the trade gap is shrinking fast as Chinese domestic consumption picks up. One way to fight trade deficit for China is letting the Yuan appreciate against the dollar. This will decrease the value of imports, analysts argue. But it will increase purchasing power for ordinary Chinese as well, further spurring domestic consumption and a possible rise in exports. Another effect of a shrinking Chinese trade balance is the diminishing appetite for U.S. Treasuries. The FED will have to raise yields on T-bills to keep China buying U.S. debt, increasing the cost of financing the U.S. economy.

But investors bet on the Yuan appreciation, as is evidenced by the sharp rise in Yuan-futures in the last three weeks. Another sign of a possible Yuan appreciation is the dramatically increased volatility of Chinese airliners in March. The sector is highly sensitive to the Yuan-dollar exchange rate because most of airliners' debt is in dollars, purchases of aircraft, while their income is in Yuan. Should the Yuan strengthen against the greenback, debt payments would ease for Chinese airliners instantly.

Despite a lackluster performance for Chinese equities in the first quarter, outlook is bright. Positive economic developments are not limited to the U.S. but Japanese Tankan survey showed increased optimism from Japan not to mention robust economic news from China. The Purchasing Manufacturers' Index rose to 55.1 points in March from 52 a month before in China, another sign of accelerating growth. Any reading above 50 means expansion. China's first quarter GDP growth accelerated while manufacturing activity increased for the 13th straight month. The increase in disposable income is evidenced by robust auto sales. Passenger car sales in China exceeded that of the U.S. in 2009 for the first time in history. GM sold more cars in China in each of the first three months in 2010 than in the U.S. and is expected to sell 2 million cars in that country for the year. SAIC Motor, the largest Chinese auto maker and GM's partner, reported net profit grew ten fold in 2009. The sharp rise in auto demand is a result of government subsidies, as part of the stimulus package introduced in early 2009, and is not expected to change for 2010.

Another positive development for Chinese equity investors was the final regulatory approval for index-futures, margin trading and short selling in Shanghai on March 26. Trading with these advanced tools is scheduled to start in April 16. Effects of the introduction of these advanced trading tools are increased trading volume, especially for large cap, liquid stocks, and with that price increase.


Anticipation that large cap stocks will rise is evidenced by their surge in the Shanghai Composite Index (SHA:000001) and the large cap heavy weight iShares FTSE/Xinhua 25 Index ETF (NYSE:FXI) in the last two days of March. Shares of Chinese insurers rose sharply after the news because a significant portion of their income is derived from investment returns, tied to the performance of large cap, liquid stocks. China Life Insurance (NYSE:LFC), the largest Chinese life insurer, got preferential treatment during mega IPOs back in 2006-2008 when Petrochina (SHA:601857) and Industrial and Commercial Bank of China (SHA:601398), among others, became listed on the Shanghai Stock Exchange. Investors expect these index heavy weights to benefit from strong money flows, boosting investment return for insurers along the way.

While not listed on American exchanges, it is important to keep an eye on Chinese financial institutions. Industrial and Commercial Bank of China (SHA:601398), the world's largest bank by market cap, reported record profits surpassing that of Goldman Sachs or any other investment or commercial bank. Profits of Bank of China (SHA:.601988), the second largest Chinese bank, surpassed Wells Fargo's, the most profitable U.S. commercial bank in 2009.


Sectors that benefit the most from the latest developments, besides insurers, are energy and real estate. Chinese oil producers, Petrochina Co. Ltd. (NYSE:PTR) and CNOOC Ltd. (NYSE:CEO), are direct beneficiaries of a stronger oil price. Both companies reported shrinking net profit in 2009 due to lower oil price, but are expected to bounce back up as price of oil recovers. Both companies reported approximately $63 / barrel average selling price of oil in 2009, leaving room for improvement for 2010. But China Petroleum & Chemical Corp. (NYSE:SNP), Asia's largest refiner, is expected to remain under pressure as refining margins worsen when the price of oil goes higher.

Chinese solar companies have reacted with sharp stock price increases due to the rising oil price. But the rally was not universal, investors favor stocks that delivered constant revenue and earnings growth for the first quarter of 2010. Chinavestor analysts identified four such companies out of eight Chinese solar payers listed in American exchanges. These are Trina Solar (NYSE:TSL) and Suntech Power (NYSE:STP), Canadian Solar (NASDAQ:CSIQ) and JA Solar (NASDAQ:JASO). For a comprehensive analysis of the Chinese solar sector based on 2009 Q4 earnings, read “Complete 2009 Q4 Chinese solar guide at

Shares of Yanzhou Coal (NYSE:YZC) have been on fire in March as the price of coal is tied to that of the oil in China. Electricity demand runs high for coal burning power plants, accounting for over 70% of all production, as a severe draught in the south hit hydropower generators hard. As a reminder, China boosts the largest hydropower plant built on the Yangtze in the Three Gorges.

Shares of E-house Holdings (NYSE:EJ) have been on fire lately. The company not only delivered a record 2009 and pays out a handsome cash dividend, but current macro trends work in its favor as well.


Talking about earnings. The online game industry is the largest money maker off the internet in China in terms of total revenues. So earnings announcements of industry leaders Inc. (NASDAQ:NTES) and Shanda Interactive (NASDAQ:SNDA) were of paramount importance. While Inc. (NASDAQ:NTES) reported 2009 Q4 revenue and earnings growth from previous quarter, Shanda’s fourth quarter earnings fell from previous one despite an increase in total revenues. Investors took it as if Shanda is not good anymore, selling off shares of the company and accumulating NTES instead. But as the dust settled investors realized that a 30% gap between the two is irrational because both companies have a large game developer base, boast a strong game pipeline and are positioned to lead the industry. Such temporary dislocations are natural and shouldn’t be over emphasized.

Wish you successful investing,

Blaze Fabry



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