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Upside looks limited for Chinese stocks for the fall

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forecast_down September, 2013 (Chinavestor) Strong global economic data for August was not enough to keep momentum going for U.S. stocks. The Dow Jones Industrial Average (INDEXDJX:.DJI) fell 5.42% for the month, the most since May 2012. The decline is attributed to two major factors. One is a possible U.S. intervention in Syria. Some argue that once U.S. involvement takes place and uncertainty disappears the index will bounce back but we don’t necessarily buy that argument. Another factor behind the current decline is that the FED is on track to start tapering off in September. We have argued that current valuations are excessive, e.g. the Dow is at all time highs despite historically high unemployment and one of the slowest economic recoveries after a recession. The good news is that strong global, primarily Chinese, data provided support for equities globally in August. The Chinese manufacturing index showed expansion along with sound factory orders. The Shanghai Composite Index (SHA:000001) rose 3.4%, the most since January 2013, making up for previous losses earlier the year. But investors in Hong Kong kept a close eye on the U.S., mitigating positive developments from China. All told the Hang Seng Index (INDEXHANGSENG:.HSI) fell 0.5% in August and is down –4.1% year-to-date (YTD). This is far better than the 7.5% decline for the Shanghai Composite or the –7.8% for the China ADR Index. This latter one is compiled by Chinavestor and takes into account all Chinese ADRs listed in the United States.

NL_201309_1

U.S. based investors interested in Chinese stocks have to keep one eye on China and the other on the U.S. History has taught us that when American equities are under pressure, Chinese ADRs are unable to fight the market.

For this reason it makes perfect sense to look at major American indexes, such as the Dow Jones Industrial Average (INDXDJX:.DJI) to get some clues about the possible outlook for Chinese ADRs. One of the ways to look at the Dow is to see where the index has been trading compared to its trading range. The chart below shows not only the Dow for the last 52 weeks but it also shows its median as well as two standard deviations below and above the mean.

DJIA_range_2013aug

The index is considered trading at extremes when it steps way out of its trading range. Either it touches the light turquoise band to the downside or the dark aqua band to the upside. Notice that these instances don’t last for long because the market gets rarely overbought or oversold to the extremes. And when it does, it bounces right back. Based on this technical analysis, the Dow Jones Industrial Average (INDEXDJX:DJI) is not oversold due to some leveling off in the last few trading days in August. This leaves the door open for additional downside despite a steep decline for the month.

This bodes ill for Chinese stock investors because as we argued, Chinese ADRs can’t fight the market on their own. Investors have to exercise caution going forward to September.

When it comes to specific stocks and sectors, we went back to the good old money flow analysis. This tool is useful to get an idea what institutional investors are doing. When a sector or a stock suffers money outflows, downside risk is on the rise. Or when a stock or sector enjoys strong money in-flows, the rally is considered solid, according to this theory.

The first, let’s take a look at how Chinese sectors did in August.

sectors_Aug2013

Capital goods way outperformed the rest while utilities fell the hardest for the month.

Running the money flow analysis for both sectors is worth a thousand words. Capital goods did not enjoy strong money in-flows in August as the money flow chart right below testifies. The index rose 11.9% in August but money flows, dark blue line, lacked momentum. We find a similar results by looking into the sector stock by stock.

MF_capitalgoods_Aug13

China Yuchai International (NYSE:CYD) and Xinyuan Real Estate (NYSE:XIN) advanced strongly in August but lack of trading volume, especially for XIN, kept money flows at bay. This suggests upside potential is limited for the sector going forward.

But the same analysis delivers some good news for the Chinese utilities sector. Despite a weak showing for August, money flows were not as terrible for sector heavy weight, Huaneng Power International (NYSE:HNP). This implies that the stock may bottom out in the near future, if the money flow analysis turns out to be accurate.

MF_utilities_Aug13

Finding individual stocks with strong momentum going forward is not easy at this time. Most stocks with spectacular performance in August came from the high risk / high return category. We have argued many times that investors should avoid Chinese ADRs that don’t meet certain thresholds in terms of market cap, trading volume, quality of auditor and public relations firm. We continue to recommend investors staying away from Chinese ADRs that went public in the U.S. via reverse merger.

So now the list of quality Chinese stocks with momentum is really down to just a very few names. One of them is Home Inns & Hotels Management (NASDAQ:HMIN), a Chinese hotel chain that delivered sound financials earlier in August. The stock did very well on August 13 and 14 before and after the announcement. Another positive development was that trading volume was also extraordinary for all of August. The stock is trading above its 50-DMA as well as its 200-DMA, a signal considered bullish by many technical analysts.

HMIN_Aug2013

We have seen signs of bottoming out for energy stocks. Yanzhou Coal Mining (NYSE:YZC) bounced back strongly In August but oil majors continued to deteriorate. But now that oil is near $110 a barrel, outlook is improving for Petrochina (NYSE:PTR) and CNOOC Ltd. (NYSE:CEO), respectively.

Wish you successful investing,

Blaze Fabry.



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