October (Chinavestor) U.S. and Chinese stocks ended September on a low tone. The Hang Seng Index (INDEXHANGSENG:.HSI) tumbled 14.3%, the largest monthly loss since October 2008. The index ended lower for the fifth month in a row, wiping out over 20% of its value for the quarter. The index is off a staggering 23.6% YTD! The Shanghai Composite Index (SHA:000001) fell for the third month in a row, this time 12.8%. The index is off 16.0% YTD sitting at a 14 month low. The China ADR Index, compiled by Chinavestor, fell 12.8% in September and is deep in the red YTD as a result. The decline among U.S. listed Chinese companies was universal, except for some healthcare and consumer cyclical names. The Dow Jones Industrial Average (INDEXDJX:.DJI) fell 5.9% for the month and is in the red YTD as a result.
Stocks of interest in this Newsletter include Aluminum Corp. Of China (NYSE:ACH), Alcoa Inc. (NYSE:AA), Google Inc,. (NASDAQ:GOOG), and Baidu.com Inc. (NASDAQ:BIDU) besides other stocks. New stock we mention is Mindray Medical (NYSE:MR) and New Oriental Education (NYSE:EDU).
In the myriad of economic news, one thing is certain: outlook remains uncertain. Problems are stemming from stubbornly high unemployment, slow economic growth, pick up in inflation, falling personal income and a large government deficit. But the housing market surprised investors with some positive developments and consumer spending, the engine of economic growth, remains robust. Besides domestic woes, Greece’s ills continue to undermine the common European currency. Consequences of Greece’s default are too dire to contemplate. China has its own problems. A slowing global economy is hurting exports while inflationary pressure and bad bank loans prompted additional monetary tightening measures. No wonder, investors remained defensive. The real question investors want to know is this. When are markets going to turn around?
There is no one who knows the answer. But keeping a close eye on one of the key reasons for the global equity plunge, certainly helps. It was the Euro, the common currency of the old continent, that moved markets in a sew-saw action in September. Going forward, we expect that to remain one major theme. We are not going to make a prediction of what’s going to happen in Europe. Instead, we give investors and advice how to benefit from the situation. The best way to play the European crisis is to raise come cash for the eventuality of Greece’s exit from the Eurozone. Should that happen, stocks will plunge from fear of the uncertain. But that creates opportunities for the intelligent buyer. After the initial shock, stock prices will recover globally, rewarding bottom fishers. Our number one advice for October is to increase the cash portion of your portfolio.
If Greece stays within the Eurozone for 2011 and markets calm down, a technical rally looks a real possibility given the steep decline of major indexes for the past five months.
One of the best ways to benefit from such eventuality is by looking at historical data. We are in the low end of a rate cycle, at times when the yield on 30 year T-bond is below 3%.
Under such rate cycle, we find that the consumer non-cyclical sector and within that “soft drinks have historically anticipated the turn and rallied three months before the market turnaround”. Source: Market Cycles, Birinyi Associates. This time we don’t see a rally yet but the sector has clearly outperformed the broad market YTD. See top chart on this page. Red line marks the S&P 500 and the blue represents the sector.
Looking at the interest rate cycle, it is apparent that “consumer non-cyclicals do best when rates go down, followed by consumer cyclicals. Banks turn down before rates increase and technology shines in the first three months of rising rates. Towards the end of the bear market, energy and soft drinks do best historically.” Source: Market Cycles, Birinyi Associates.
Looking to the two charts right above, it is apparent that financials are still hurting, just as expected. But the lack of momentum in the energy sector suggests the bears still control the driving seat.
Assuming that rates will stay low for a long period, as indicated by FED Chairman Mr. Bernanke, investors better pay attention to stocks within the Consumer Non-Cyclical and Consumer Cyclical sectors right now.
Additionally, it is smart to be prepared for an eventual recovery. The same study from Birinyi associates finds that “Early rising rate cycle sectors are technology and health care”.
Translating all this to the stock level, we have an issue with specific Chinese names. We like stocks that have credible institutional ownership, sound corporate governance and quality auditors. But no stock from the consumer cyclical and non-cyclical sectors qualify for such criteria. Those issues are important especially now that the Department of Justice got involved in an SEC probe that questions corporate governance of reverse merger Chinese stocks. We dedicated a whole issue of a Newsletter back in July, titled “Reverse Merger Stocks Fail Investors”. We will be happy to send investors a copy of that important fact finding paper. The Wall Street Journal has just dedicated a good sized article on the front page of the business section today. Again, we are of a view that Chinese companies above $250 million market cap can, and increasingly need to, afford a big four auditor. We continue to prefer stocks that went public via IPO and not a reverse merger. The good news is that all top seven technology names did just that.
That said, stocks we prefer from the technology sector include Baidu.com Inc. (NASDAQ:BIDU), Sina Corp. (NASDAQ:SINA), NetEase.com Inc. (NASDAQ:NTES) and Sohu.com Inc. (NASDAQ:SOHU), albeit these stocks were slaughtered at the end of the month. Most of the decline is due to increased risk awareness. Fears of a double dip recessions are real, resulting in a massive sell-off of the best technology names. Despite the free fall in September, we continue to like the best technology stocks. Besides internet, solar stocks suffered dearly on outlook concerns. Europe is the largest export market for Chinese solar makers and with subsidy cuts in Italy and Spain, there seems to be more supply than demand. Fight for market share resulted in falling prices, hurting profitability. No wonder, the best names in the sector lost 80% of their value YTD.
The good news is that with earnings season around the quarter, investors will get a chance to asses corporate earnings, a cornerstone of stock valuation and prices.
Alcoa Inc. (NYSE:AA) is the unofficial opener of the earnings season with ramifications felt by Aluminum Corp. of China (NYSE:ACH). Google Inc. (NASDAQ:GOOG) is the benchmark for technology stocks in large and for Baidu.com Inc. (NASDAQ:BIDU) in particular. Google Inc. (NASDAQ:GOOG) is scheduled to report in the middle of October.
New Oriental Education (NYSE:EDU), by far the largest Chinese stock from the education sphere, will report earnings on October 18, the first major Chinese listed company to do so. But investors will have to wait until early November to gain sufficient insight into the technology sector. This is when Baidu.com Inc. (NASDAQ:BIDU), Sina Corp. (NASDAQ:SINA) and the rest will start reporting third quarter financials.
The best stock from the health care sector is Mindray Medical (NYSE:MR). This is a mid sized medical equipment maker with a solid top and bottom line growth and has been part of the Conservative Portfolio for most of the year.
For additional stock picks, please visit the Conservative and Growth portfolio.
We wish you successful investing,