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Liquidity risk is on the rise for Chinese ADRs

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risk_2 May 2013 (Chinavestor) The month of April continued where March left off: surging U.S. equities and falling Chinese counterparts. In fact, the Dow Jones Industrial Average (INDEXDJX:.DJI) and the S&P 500 both reached all times highs in April and continue to show strength. All told, the Dow advanced 1.8% in April and is up 13.2% year-to-date (YTD).

In contrast, Chinese stocks fell in Shanghai sending the broad index 2.0% lower for the month. The Shanghai Composite index (SHA:000001) is off 4.0% YTD. Most of the fall is attributed to uncertain global demand for Chinese goods. The European Union, China’s largest trading partner, is in deepening recession. China’s manufacturing activity fell in April and was below forecast, sending the Shanghai Composite into a tailspin in April.


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Investors in Hong Kong are in between the USA and China. The Hong Kong dollar is pegged to the US greenback and so is the interest rate. No wonder, the “currency war”, a phenomenon that will be addressed in this issue later, benefitted Hong Kong stocks, sending the Hang Seng Index (INDEXHANGSENG:.HSI) 2.0% higher in April. Yet the index is barely above the water and is up 0.4% YTD.

One would assume that Chinese equities listed in the US would likely benefit from a strong investor sentiment in the US. But reality is different. Among all categories followed by Chinavestor, the China ADR Index fell the hardest in April and for YTD as well. In fact, the China ADR Index, measuring the performance of Chinese ADRs listed on the NYSE and the NASDAQ, fell 6.2% in April and is off 19.7% YTD!

Looking for explanations we have to let the essence of our previous Newsletter, titled Quality Chinese ADR is hard to find, to sink in. In that issue we argued that due to an increasingly competitive and confrontational political situation between the US and China, Chinese ADRs fell out of favor among US investors.

We also have to point out that it’s not just politics to blame. Chinese policy makers are no help in fighting rampant abuse of Chinese microcap companies on US soil. As investor confidence is drying up, even quality companies are finding it hard to attract sufficient trading volume. China Eastern Airline (NYSE:CEA), a highly liquid Chinese carrier in listed in Shanghai and Hong Kong in addition to the NYSE, has a trading volume of a few thousand ADRs a day, a fraction of what it used to be a few years ago. Again, this company is the second largest carrier in China by fleet size and has a 50% plus market share above the skies of Shanghai, China’s financial capital.

In essence, Chinese ADRs are facing an uphill battle for liquidity as a result of lack of investor interest. This may explain the free fall of the China ADR index lately. The bad news is that the future looks uncertain at best.

Another problem Chinese equities face is the result of, as I call it, “competitive currency devaluation”.

Bank of Japan announced plans to double the monetary base in two years, a move that helped the yen to weaken 20% again the US dollar. The move is seen by many as a reaction to the FED printing machine as Japan is competing with US exporters in the greater and increasingly important Asia-Pacific region. Remember, the FED continues to buy treasury bills worth $85 billion/month, or over $1 trillion a year!

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Some of this money finds ways in equity markets and increases risk appetite. No wonder, the Nikkei 225 had its best 3 months run in years and the Dow is at record highs on the same time as the chart above testifies.

Lack of Chinese stimulus and a deepening recession in Europe keep equities at bay for these regions. Industrial production decelerated and is hurting Europe, just as the chart on this page testifies. A similar measure, unemployment, is also an objective indication about the troubles brewing in the old continent. Going forward, outlook remains dim in the Eurtozone where northern members push for more austerity, pushing southern members deeper into recession. Italy, Spain and Greece, among others, continue to live on the European Cental Bank’s umbilical cord. Europe’s competitiveness in the global arena is waning due to big government spending due to entitlements, among others.

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As long as Europe remains in recession, China is going to feel the pain. While earnings should be on the forefront of ADR performance and valuation, macro economics continue to drive prices.

Turning to stock specifics, we continue to like the Chinese sector indicator for ideas. Utilities, to be exact, Huaneng Power Int. (NYSE:HNP), continues to outperform. We have highlighted strong money flows in the past reasoning that the rally was not over. This remains the case right now as we continue to see strong money flows into the stock.

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Financial and tech stocks outperformed the rest in April as the following chart testifies. China Life Insurance (NYSE:LFC), the largest life insurer in China and the sector heavy weight, advanced 4.0% for the month. The advance is attributed to a recovery after a 25% decline earlier the year. The stock is still deep in the red since January 2013.

Technology stocks were mixed but some of the household names reacted positively to sound earnings. Among them Sina Corp. (NASDAQ:SINA) rose 15.7% and Qihoo 360 Technology (NASDAQ:QIHU) advanced 16.2%.

Most of the bang came from the upbeat solar sector. Suntech (NYSE:STP) bounced back 69.2% from a base of $.36 but again, that’s due to a very low base. As you may recall, we have kept a close eye on the sector, understanding that volatility is unsuitable to prudent investors. Just for the records, Trina Solar (NYSE:TSL) rose 35.8% and Yingli Green Energy (NYSE:YGE) surged 27.9%. Despite such “impressive” numbers for April, investors have to stay away from the sector.

Other than the defensive services sector, all other Chinese sectors were in the red for April.

We continue to look for additional clarity into Chinese ADRs, until then we wish you successful investing,

Blaze Fabry.



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