November 2013 (Chinavestor) There isn’t much change from last month when it comes to outlook for Chinese stocks. We have said in the last two Newsletters that upside looks limited for Chinese stocks for the fall, and we stick to it. The Shanghai Composite Index (SHA:000001) rose for the month but is still in the red for the year. The same goes for Chinese ADRs or U.S. listed Chinese stocks. The China ADR Index, compiled by Chinavestor, rose 3.2% in October but is –5.3% down YTD. The only major Chinese index that is in the black YTD is the Hang Seng (INDEXHANGSENG:.HSI). But again, all these Chinese indexes continue to underperform the Dow Jones Industrial Average (INDEXDJX:.DJI). Why is that?
One of the easiest answers is that while the Dow and as a matter of fact every major US index is boosted by artificial flow of funds, most argue that the QE is behind the move, Chinese stocks lack such boost. The lack of momentum among Chinese stocks is partially attributed to the fact that Chinese equities have to adjust to a slower growth rate in China after thirty years of hyper growth.
But what western investors in the US should get to the bottom of is why US listings remain such underdogs? Ideally the China ADR index should be somewhere between the Dow and the Hang Seng, shouldn’t it?
Despite eye popping headlines like “Investors regain a taste for China” from the WSJ on October 28, 2013, reality is that US investors continue to shun US listed Chinese stocks.
Another way to illustrate this is by comparing the overbought/oversold monitor for components of the Dow and Chinese ADRs for the same day, October 31. Most Dow components have momentum while only one Chinese ADR shows similar characteristics. See chart below.
Similarly, there is a yawning difference on the oversold side, too. Only a handful of Dow components fell vs. a large number of oversold Chinese stocks the same day.
This is a prime example how different Chinese stocks behave on US markets compared to their American counterparts. So to say that there is a taste for Chinese stocks at the moment is an overstatement.
We continue to believe that Chinese stocks don’t live up to expectations due to lack of investor interest. There has been a lot of damage done to US investors in the past. Let’s just mention the huge number of Chinese stocks delisted from the NYSE and NASDAQ. The problem is that fraudulent Chinese companies left such a collateral damage that it will be hard to overcome.
Let’s illustrate this point by looking at the latest bar chart for Google Inc. (NASDAQ:GOOG) and its Chinese counterpart, Baidu.com Inc. (NASDAQ:BIDU).
Google Inc. reported earnings on October 17 and the stock jumped from $888 to $1011 in just one day. Just as importantly, Google Inc. continued to show strength and firmly established itself above the $1,000 mark.
Turning over to Baidu’s reaction to Google’s earnings, the first observation is that BIDU jumped on the news. But the jump was a lot less significant as the second chart on this page testifies. Not only that but BIDU fell for a consecutive three days following the jump and continues to trade in wide range.
In other words, the strong bond between these two iconic stocks is not nearly as strong as it was a few years ago.
Another problem US investors interested in Chinese stocks have to overcome is the under-informed media. Think about what has just happened today. Chinese manufacturing data showed strength but regional indexes failed to gain traction. What were the first three headlines on major media outlets?
- “Stocks in Asia were mostly lower Friday after an official gauge of last month’s Chinese factory activity showed signs of weakness”. (WSJ- Asian shares fall on China PMI).
- “Asia’s factory sectors grew at their fastest pace in months in October led by China…” (Reuters—China shares eke out weekly gain as PMI survey supports).
- “China’s official manufacturing Purchasing Managers’ Index rose more than estimated to an 18 month high” (Bloomberg—Manufacturing strengthens from China to South Korea).
Three articles with three different views on the same number. Our interpretation is that Chinese stocks failed to gain momentum due to anxiety over FED driven US markets.
Back to the point, we continue to turn our heads when journalists express their opinions about something of which they have no idea. And China and Chinese stocks are unfortunately in this category. We continue to believe that stocks with solid fundamentals will outperform the market but investors have to keep their eyes on the market, too. Take a look at how Chinese stocks did in October. Consumer non-cyclical and capital goods stocks outperformed along with the tech sector while services and health care stocks lagged behind.
But the devil is always in the details. For one, there is not a single capital goods or consumer durable stock among Chinese ADRs that I could heartily recommend for investors.
Synutra International (NASDAQ:SYUT) is largely responsible for the superb performance of consumer durables yet the stock has had its rough ride and is only shining because it started from a very low basis.
The same goes for the capital goods sector. China Yuchai Int. (NYSE:CYD) and China Ming Yang (NYSE:MY) are responsible for the strength but none of them meet Chinavestor investment criteria based on trading characteristics, listings history and quality of auditor, among other things.
The tech sector is a lot better diversified and has some excellent listings in there. But our money flow analysis reveals that the index ran way ahead its money flows, see second chart on he page. This suggests the strength is not well founded and that the sector is vulnerable to downside.
See our Conservative and Growth portfolio updates to find stocks we like.
Wish you successful investing,