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It’s all about the FED

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FED August, 2013 (Chinavestor) July was another month for the record books. While stocks ended the month mixed, the overall picture is clear: broad FED instilled rally. The Dow Jones Industrial Average (INDEXDJX:.DJI) soared 4.0% in July and is up a staggering 18.3% year-to-date (YTD). The index has risen to 28 record closes this year by the end of the month. Other key American indexes enjoyed the party as well. The S&P 500 rose broke through the 1,700 level for the first time ever and the Nasdaq Composite had its best month since January 2012.

But Chinese stocks continue to drag their feet. There has been an ever widening gap between the performance of the Dow and the Shanghai Composite Index (SHA:000001), just as the chart on this page suggests. The Shanghai Composite Index (SHA:000001) advanced a mere 0.7% in July and is still down –12.1% YTD. The China ADR Index, compiled by Chinavestor and measuring the performance of U.S. listed Chinese ADRs, advanced half as much as the Dow and is still deep in the red for the year. Investors continue to shun Chinese ADRs for the most part. However selected technology stocks regained their former glory. More about the sector in the second part of this Newsletter.


The Hang Seng Index (INDEXHANGSENG:.HSI), another useful benchmark for Western investors, rose 5.0% in July and is on a good track to get back to the black for 2013.


We continue to believe that equity markets are primarily driven by the excess liquidity provided by the FED and secondarily by macro economic news.

The housing market continues to show improvement just as the chart on this page testifies. The number of housing units available for sale, e.g. housing stock, is back to 2002-2003 levels while the number of sales, e.g. houses sold, continues improvement. Data suggests U.S. housing prices surged in July, Denver and Dallas were particularly sound. The S&P/Case-Shiller 20-City Composite Index advanced 12.2% YTD and has been accelerating. Sales of new homes hit highest rate in five years in July, data suggests. But investors have to realize that gains in interest rates are expected to hurt demand going forward.


The jobs market continues to heal albeit at a slow pace. The private sector added 162,000 news jobs in July, according to the latest ADR report. That number was below analysts’ expectations and revised figures lowered the jobs gained for June. Since the beginning of the year, 900,000 jobs have been added, but part time jobs accounted for over 700,000 of the new jobs. Unemployment remains high and there is a lot more room left for improvement. Data shows that the U.S. economy added 6 million jobs since hitting the bottom in 2010, but that’s still the slowest jobs recovery after a recession since WWII.

Consumer sentiment rose to a six year high in July, according to University of Michigan/Thomson Reuters data. Consumer sentiment is important for the American economy where consumer driven demand and consumption is responsible for most GDP growth. U.S. GDP growth was 1.7% in the second quarter, a smaller number than in the first quarter. Overall GDP growth for 2012 is now estimated at 2.2%, according to the Commerce Department.

But again, we are of a view that the FED and not economic news are behind the superb performance of U.S. equity markets. The FED hinted late in July that there is no imminent change in the controversial bond-buying program, encompassing $1 trillion a year. Given that the U.S. government debt will reach a ceiling in the fall, investors have to expect more political bickering and force the FED to change course. This will translate to additional market volatility with significant downside potential.


Looking at China for the moment, the middle kingdom has it’s own problems. One of the most obvious numbers to look at is real GDP growth. China’s economic growth slowed to 7.5% in the second quarter with no indication that it would pick up speed any time in the near future. The new government seems content with trading slower economic growth for structural reform. One of the most important changes in China is that the new government is making an effort to suck out excess liquidity from the bank sector. Banks have provided most of the funds for China’s real estate boom but failed to go to productive sectors, according to the government. Latest measures to tighten credit are aimed at slowing the real estate sector but its effects are yet to be seen. One thing is for sure though: both loan and deposit growth fell significantly from 2008 records as the chart on this page testify. Inflation is not a concern in China at the moment, giving the government a free hand setting interest rates for now. Consumer demand was modest at best with the automotive sector providing a sweet spot. Car sales reached 1.40 million units in June, just ahead of 1.39 million in the U.S.


Looking at Chinese stocks listed in U.S. markets for July, the picture is mixed. Technology and consumer cyclical stocks outperformed the broad market by a wide margin. The good news is that the rally was somewhat universal among technology stocks but most of the gain in the consumer cyclical sector is attributed to just one stock, the highly speculative China Automotive Systems Inc. (NASDAQ:CAAS). This stock surged 23.5% but is of low trading quality in our opinion. We continue to encourage investors to stay away from stocks under $250 million market cap for a number of reasons.


This line of thought gets us back to the technology sector. Inc. (NASDAQ:BIDU), the largest from the sector measured by market cap, surged 39.9% in July and is trading well above its 50-DMA and 200-DMA as well. See chart on this page for details. Again, it wasn’t only BIDU that did well in July from the sector. Sina Corp. (NASDAQ:SINA), another sector heavy weight, rose 23.8% while prominent Qihoo 360 Technologies (NASDAQ:QIHU) surged 40.9%. Video sharing portal Youku Tudo Inc. (NYSE:YOKU) rose 15.6% as well. A broad rally suggests appetite for moderately risky technology stocks is on the rise.


But it wasn’t a cake walk for most Chinese stocks in July. Basic materials fell –0.2% in July and energy stocks suffered a loss of –0.1% as well. Sector heavyweight Aluminum Corp. of China (NYSE:ACH) fell –2.2% for the month all but mitigating advances of smaller Silvercorp Metals (NYSE:SVM) and China Natural Resources (NASDAQ:CHNR). The same happened to the energy sector: Sinopec (NYSE:SNP) fell –18.8% cancelling out advances from the rest of the sector.

Wish you successful investing,

Blaze Fabry.

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