August 2011 (Chinavestor) July gave testimony again that the global economic recovery is missing legs. GDP growth in the U.S. crawled to 1.3% for the second quarter, making it the slowest six months on record since 2008. Consumer sentiment fell as the latest the survey by the University of Michigan showed in July, making economic recovery so much more difficult. Investors have to bear in mind that consumer spending is responsible for two thirds of economic activity. When consumers don’t spend, the economy just can’t grow fast enough to create jobs. As far as the jobs market is concerned, the picture is far from rosy. First time jobless claims fell to under 400,000 in the last week of July for the first time since April, yet the pace of jobs creation is far from sufficient to drag the economy out of its current mess. On top of economic problems, the political leadership fell short of the task as well. Political posturing around the increase of the debt ceiling led to a potential downgrade of U.S. debt, hamstringing the all needed economic recovery.
Stocks of interest in this Newsletter include Baidu.com Inc. (NASDAQ:BIDU), Sohu.com Inc. (NASDAQ:SOHU) and Changyou.com Inc. (NASDAQ:CYOU) from the internet sphere. 51job Inc. (NASDAQ:JOBS) and Ctrip.com International (NASDAQ:CTRP) are also stocks mentioned in this report.
All told, investors sent the Dow Jones Industrial Average (INDEXDJX:.DJI) tumbling 537.9 points, during the last week of July, the most for any week in 2011. The 4.2% dive effectively erased all previous gains for the month, sending the index 2.2% lower for the month. Despite a disappointing month, the Dow Jones Industrial Average (INDEXDJX:.DJI) is still up 4.9% year-to-date.
The performance of Chinese stocks listed in U.S. suggests that U.S. investors haven't shun China stocks as much as their Asian counterparts have. The China ADR Index is up 4.4% YTD, far outperforming the Hang Seng Index (INDEXHANGSNEG:.HSI) and the Shanghai Composite Index (SHA:000001) for the same period. But the picture may change sooner than later if our assessment is right. The main Chinese index was kept under pressure by ever increasing bank reserve ratios and interest rate hikes. Investors have feared that excess tightening may choke off growth. But here is the game changer. Now that China seems to be able to reign in inflation and manufacturing activity has slowed, Chinese policy makers have increasingly been vocal about the end of the tightening cycle.
Certainly encouraging is that fact that core inflation in China has been leveling off in May-July period, as evidenced by the chart to the right. Food prices have been the main driver with pork price increases taking the lead within the food basket, but that cycle is about to end as measures to ease shortages have been put in place.
Additionally, the global economic recovery remains fragile, another factor that Chinese policy makers have to consider. All told, it looks like that we’re closer to the end of the tightening cycle than to the beginning and as such there is real upside potential for the Shanghai Composite Index (SHA:000001) and its trailing ETF, the Morgan Stanley China A-share fund (NYSE:CAF).
When it comes to global economic recovery, problems are not limited to the U.S.
Europe is mired in solving the Greek debt crisis by trying to contain the spread of possible government defaults. Should Greece fall off the eurozone, chances are that Portugal, Ireland and Spain will follow.
Japan, the third largest economy after China, is still entangled in the deflationary trap with a strengthening yen making economic growth difficult. The country has an extremely high government debt-to-GDP ratio, a non-performing stock market, and recurring current account surpluses.
China is the only “sweet spot” among major economies when it comes to economic growth. The country reported a second quarter GDP growth of 9.6%, higher than consensus estimates of 9.5%. The good news for investors is that while the economy continues to run in high gear, inflation may be contained. At least this is what China’s Premier, Wen Jiabao, declared in July.
Manufacturing activity, measured by the change in purchasers’ managers index, fell in July from June but is still showing expansion, a sign that China is avoiding a hard landing. The latest five-year plan calls for a construction of 1 million new units of affordable housing, an effort to deflate the supply side of the real estate bubble.
Consumer spending remained robust in China if car sales is used as a gauge. June passenger car sales were above 1 million units despite the lack of government subsidies. Finally, corporate earning growth remained robust and investors will learn soon just how good they really are.
We like what we’ve seen so far. The most valuable Chinese internet company. Baidu.com Inc. (NASDAQ:BIDU), reported earnings on July 25th and it was a classical “triple play”. The company beat revenue and earnings estimates handsomely and guided higher than previous forecasts. The good news on top of the sound results is that all this is “quality earnings”, e.g. not a one time item but a result of sound revenue growth and prudent financial management.
While it might have been a surprise to many, we were expecting some outstanding numbers from the company based on historical performance. Baidu.com Inc. (NASDAQ:BIDU) has been beating earnings estimates in the past five quarters as the chart to the right testifies. It’s not that we knew what was going to happen but we had a higher than average level of confidence that Baidu.com Inc. (NASDAQ:BIDU) would beat estimates. This is why we kept the company in the Growth portfolio for the month of July as well as in the weekly stock list as BUY before the earnings announcement. Given the subsequent gloomy week, the stock hasn’t reached its potential in our judgment.
Another internet stock we’ve been following closely is Sohu.com Inc. (NASDAQ:SOHU). This internet company operates one of the largest web portals in China along with Sina Corp. (NASDAQ:SINA) and Tencent Holdings (HKG:0700). It doesn’t take a genius to expect record numbers from Sohu.com Inc. (NASDAQ:SOHU) given Baidu’s strong revenue and earnings growth as well as its quality earnings. The internet sector is not only hot but has more upside left given the market is far from being saturated. Sohu.com Inc. (NASDAQ:SOHU) will report after this Newsletter is written and as such we’re anxious to see actual numbers.
When it comes to Sohu.com Inc. (NASDAQ:SOHU), investors should not forget Changyou.com Inc. (NASDAQ:CYOU), formerly the online game arm of the company. After spinning off Changyou.com Inc. (NASDAQ:CYOU), Sohu kept over 50% of its shares and has been able to incorporate its book to its own. Changyou.com Inc. (NASDAQ:CYOU) has been highly profitable in the past and is expected to remain that way - at least for the near future.
Looking at the earnings calendar for the rest of the month, there are a couple of heavy weights, other than those mentioned before, worth paying attention to.
Ctrip.com International (NASDAQ:CTRP) is one of the largest Chinese NASDAQ listings by market cap. The company is primarily engaged in the online travel business in China. Looking at historical revenue and earnings growth, the company has been superb for most of the time. Rich valuation may keep some investors away but if history is any guide, chances are that Ctrip.com Int. (NASDAQ:CTRP) will surprise investors to the upside on Monday.
Large cap HSBC Plc. (NYSE:HBC) is a bank headquartered in London but is one of the most heavily engaged foreign banks in China. The stock is triple listed with a heavy secondary market in Hong Kong and is one of the largest components of the Hang Seng Index (INDEXHANGSENG:.HSI). Financial stocks may be first hand beneficiaries as the end of the monetary tightening is about to come.
The first week of August will see another important and liquid China ADR to report: 51job Inc. (NASDAQ:JOBS). The company is engaged in the online job market and has a significant print advertisement business as well. Given the fast rise of the more profitable online job market within the company’s operations, margins and bottom line have been steadily improving over the last two years. Investors may be surprised again on Thursday if history is any guide.
Wish you profitable investing,