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Chinese stocks in 2013 and beyond

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Asia_2 January, 2013 (Chinavestor) The beginning of a new year is always an opportunity to assess lessons learned from the last year and to address what to expect from the upcoming one.

For the record books: the Hang Seng Index (INDEXHANGSENG:.HSI) advanced 20.0% in 2012, the most among major indexes tracking Chinese stocks world wide. While the jump looks excessive, one has to remember that the Hang Seng Index has been historically a lot more volatile than its US counterparts. Investors don’t have to go back far to find a jump of 51.5% in 2009 that came on the heels of a 43.4% dive a year earlier.

The China ADR Index, tracking the performance of Chinese ADRs listed on the NYSE and NASDAQ, rose 11.2% for the same time. This advance was twice as much what the Dow Jones Industrial Average (INDEXDJX:.DJI) registered for 2012.

Stocks surged as much as 14.6% in December in Shanghai, bringing the index back to the black for all of 2012. Yet investors had a rough ride with the Shanghai Composite Index (SHA:000001) for the second part of the year, except for December. Investors that sold off at the beginning of December were left in the cold. This again is a stark reminder that timing is key in investing.

Major Indexes in 2012

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One lesson investors learned was that stocks in Shanghai remained extremely volatile. This favors the high risk takers but hurts conservative investors. Another lesson learned from 2012 was that politics had less to do with overall market sentiment than many had thought. The long fought presidential election had a little impact on the overall performance of US indexes. The DJIA remained in a relatively narrow band for most of the year and even the drama building around the “fiscal cliff” did little damage to the markets. Today’s ADP numbers carried the same message that despite the potential fallout from the fiscal cliff, companies continued to hire aggressively in December.

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What interests us most is what to expect in 2013. China’s GDP growth is expected to be around 8%, well above that of regional rivals. The relationship between GDP growth and stock market performance is complex at best but one thing is sure. When an economy expands fast, just as Japan did up until the 1980s, the stock market reacts favorably for a prolonged time period. Growth in Taiwan and South Korea has slowed and so did the return of their major stock market benchmarks. But China is still growing fast, giving investors a reason to be bullish on China for at least ten years.

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But here is the trick. Investors found it increasingly difficult to separate the darlings from the dogs. One lesson learned from not just 2012 but over the last three years is that TRANSPARENCY is key when it comes to Chinese stocks listed in American stock exchanges.

2012 brought in a record number of failed Chinese ADRs, hurting overall interest for Chinese stocks. Volume has dried up not only for small cap, less transparent stocks but for some big ticket names such as China Eastern Airlines (NYSE:CEA). Investors find it hard to sell even a few hundred shares of CEA, not to mention a block. This in turn may spell a death knell for some quality Chinese stocks that fail to attract sufficient investor interest. Recall what happened to Brilliance China Auto (HKG:1114), the first Chinese listing on the NYSE? Remember, this is BMW’s Chinese partner, a company with market cap of over $6.8 billion. Lack of investor interest coupled with high NYSE listing cost due to Sarbanes and Oxley, the company withdrew from the US. Yet it continues to trade heavily in Hong Kong.

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While an orderly withdrawal from the NYSE shields investors from disaster, most small cap delisting stocks resulted in significant financial losses. We have been advocates of avoiding questionable stocks at Chinavestor for a long time, a call we extend for 2013 and beyond. Investors should not touch stocks whose operations/products can’t be independently verified. What might have slipped through the lines but is important to keep in mind is the SEC’s failed outreach to the China Securities Regulatory Commission (CSCR) late 2012. The SEC tried to persuade its Chinese counterpart to do additional due diligence of Chinese companies that are seeking listing in the US to no avail. Unfortunately for US investors, bookkeeping of some of the Chinese companies listed on the NYSE and NASDAQ are not considered Vanguard.

We continue to recommend stocks that have verifiable products/services, sufficient market cap and trading volume along others.

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Huaneng Power Int. (NYSE:HNP), the largest Chinese independent power generator, was one of our top picks in 2012. The stock has anchored in our portfolios for most of 2012 to the pleasure of our subscribers. Good news is that the stock not only attracted strong money flows in the US, but at its home market in Shanghai and Hong Kong as well. This in turn suggests that despite the recent run up, downside risk looks manageable.

Going forward we continue to like basic materials, energy and financial stocks as China’s rapid urbanization unfolds. The tech sector remains tricky and is recommended for investors with high risk tolerance. Internet and even more solar stocks offer upside potential but that comes at a considerable risk. While we like the Chinese consumer durable and industrial sectors by principle, investors have little choice when it comes to Chinese ADRs. Wish you successful investing,

Blaze Fabry.



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