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Double dip fears sink China stocks

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decline_9 September, 2011 (Chinavestor) Worries about the health of the global economy sent stocks tumbling at the beginning of August. Despite some bargain hunting instilled strength at the end of the month, investors are in the red for August. The Dow Jones Industrial Average (INDEXDJX:.DJI) fell 4.5% for the month but thanks to the last three days of trading, the index is back in the black year-to-date (YTD). Chinese stocks trading in the U.S. are the closest to the performance of the Dow, for the index is barely in the red YTD. The China ADR Index, compiled by Chinavestor, is off 1.1% YTD, way outperforming key Chinese indices such as the Shanghai Composite Index (SHA:000001) and the Hang Seng Index (INDEXHANGSENG:.HSI).

This latter one is off over 10% YTD after a 8.5% dive in August! Investors in Hong Kong turned defensive in line with the U.S. at the beginning of the month when fears of a double dip recession emerged. Price of gold hit a new record over $1870 an ounce as investors fled to safety. The fall of oil prices were a mixed bag for the market. Airliners and upstream oil companies advanced as margins improved but energy stocks fell.

Stocks of interest in this Newsletter include Sina Corp. (NASDAQ:SINA) and Inc. (NASDAQ:BIDU) from the internet sector. Financials of interest are HSBC Plc. (NYSE:HBC), Bank of America (NYSE:BAC), Wells Fargo (NYSE:WFC) and Goldman Sachs (NYSE:GS). Key ETF of the report is the iShares FTSE/Xinhua 25 China (NYSE:FXI).


Credit woes within the weakest members of the euro-zone prompted downgrades and more expensive credit, setting up potentially Italy and Spain on the "death curve" of even more expensive credit. On top of lack of confidence in the euro's future, Germany reported a mere 0.2% GDP growth for July, shocking financial markets. Germany, the largest economy and the growth engine of the euro-zone, is critical in restoring economic growth and confidence into Europe's economy.

Besides problems of the euro-zone, the U.S. had its share of pain in August. The country's credit rating lost some of its shine after a first ever downgrade by S&P to AA+ from AAA with a negative outlook! This was a shocker to markets, greatly adding to the panic at the beginning of the month.

The Shanghai Composite Index (SHA:000001) lost 5.2% in August, the most in 2011, and is off 8.6% in 2011. Most of the weakness in Shanghai is due to administrative measures that aim to keep inflation in check. Chinese financial regulators have raised bank reserve ratios, e.g. cash financial institutions have to set aside, several times this year. The latest round of such increases came as late as August 29, Monday. Each and every financial stock fell hard after the news despite reporting record profits just weeks before. And just how profitable Chinese financial institutions have become is eye popping on the following chart.


Industrial and Commercial Bank of China (HKG:1398), the largest Chinese bank, reported net income of $8.732 billion for the second quarter alone! For the first six months of the year, the bank made over $17 billion, more than the entire U.S. banking system at the same time and almost as much as it did in all of 2010! Bank of China (HKG:3988) is looking just as strong as ICBC after reporting net profits of $10.428 billion, close to what it made in all of 2010 as well. Wells Fargo (NYSE:WFC) remained the most profitable U.S. financial institution with $3.948 net profit for the quarter. Goldman Sachs (NYSE:GS), the most profitable in the past two years, fell back and made only $2.735 billion in the second quarter. Not only did Goldman make less than Wells, but its earnings remained extremely volatile.


Bank of America (NYSE:BAC), the bank that every other American makes business with, reported a net loss of $8.826 billion for the second quarter after a $2.049 billion profit in 2011 Q1. Such steep losses needed replenishment of capital, something that Bank of America (NYSE:BAC) did swiftly. First, Warren Buffet made headlines by investing $5 billion into the troubled financial institution. Besides the cash, Bank of America (NYSE:BAC) got a lift in credibility like Goldman did back in 2008 at the height of the financial meltdown. The stock surged 25% that day, its best daily gain in years! Besides Buffet's cash infusion, Bank of America (NYSE:BAC) sold 13.1 billion shares of Construction Bank of China (HKG:0939), the second largest Chinese commercial bank. The sale netted $8.3 billion into the coffers of Bank of America (NYSE:BAC). After the sale, BAC still owns just about 5% of CCB's shares outstanding.

The importance of the banking sector is that it is widely used as a gauge for the health of the entire economy. Given that Chinese financial institutions reported quality earnings, e.g. earnings driven by record lending and not by some financial gimmicks, there is mounting evidence that the Chinese economy remained resilient despite slowdown in Europe and the U.S. This is good news for China stock investors for the long run! While Chinese stocks tend to fall along with global markets, strong corporate earnings continue to make them attractive on valuation. It's just a matter of time before investors globally will pour money into quality Chinese equities.

With that said, we continue to like companies that are industry leaders in their respective fields with strong earnings and sound cash positions. The month of August was a month when most Chinese companies reported earnings, giving investors plenty of fuel to make decisions.

We just highlighted the strength of the Chinese financial sector. Chinese banks were not just profitable but have been increasingly profitable as the chart on page two testifies. The bad news is that investors in the U.S. have no access to any of those listings. All those financial institutions from Industrial and Commercial Bank of China (HKG:1398) to Bank of China (HKG:3988) are listed in Hong Kong and the Shanghai Stock Exchange, not on the NYSE. One of the most exposed western banks to the Chinese financial sector is HSBC Plc. (NYSE:HBC) trough its 20% stake in Bank of Communications (HKG:3328). Besides individual stocks, investors can get exposure to China's profitable banking sector via the most liquid Chinese ETF, the iShares FTSE/Xinhua China 25 Index (NYSE:FXI). While this ETF is diversified across the board, it is a financial heavy weight with over 50% of its assets coming from that sector.


Another sectors we have been following closely are the Chinese solar and internet sphere. Yingli Green Energy (NYSE:YGE) was the best positive surprise among solar makers while large industry leaders continued to suffer. Part of the problem is that their largest export market, Europe, has reduced subsidies thus hurting demand. Until that fundamental weakness gets a favorable resolution, Chinese solar stocks will remain volatile. While they may look attractive on valuation at current prices, deteriorating top and bottom lines of industry leaders call for caution.

Earnings from the internet sector were a mixed bag as well. Inc. (NASDAQ:BIDU), the largest Chinese search engine company, reported record sales and profits again. The company issued a bullish outlook yet failed to break though the $150 resistance level on market weakness. We remain bullish about this company due to its strong market position, sales and earnings growth. Investors liked what Sina Corp. (NASDAQ:SINA), one of the largest internet portals, had to say. The company reported strong revenues but net income fell due to related heavy investments. Most of these costs have been communicated to the investment community before, minimizing any negative fallout from a weak bottom line. Regarding, investors consider it a potential golden egg for its large traffic remains unrivaled in the micro blog arena in China. We continue to like Sina Corp. (NASDAQ:SINA) at Chianvestor.

Investors seem to have missed sound revenue and earnings growth of Inc. (NASDAQ:SOHU) and Inc. (NASDAQ:NTES). Both reported record revenues and earnings yet were caught in the downward spiral for most of the month. Inc. (NASDAQ:NTES) is the largest online game developer and operator in China and is highly profitable. Inc. (NASDAQ:SOHU) is somewhat smaller than Tencent Holdings (HKG:0700) or Sina Corp. (NASDAQ:SINA), yet it is one of the best Chinese internet stocks in terms of profitability.

Large cap Chinese stocks from the telecommunication and energy sectors reported at the end of the month which gave our power deprived staff a break in the wake of hurricane Irene. We will revisit those companies in the next issue.

Until then we wish you successful investing,

Blaze Fabry

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