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Bubble burst: the earlier the better

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bubble_2 December, 2013 (Chinavestor) November continued where October has left off; strong performance from US equities. The Dow Jones Industrial Average (INDEXDJX:.DJI) closed at another record by the end of the month, this time above the 16,000 mark for the first time ever. The index is up a staggering 22.8% year-to-date (YTD), far outperforming Chinese listings at home and abroad. Good news for US investors with a China spin that the China ADR Index, measuring the performance of US listed Chinese equities, rose 7.8% in November, the most in 2013. Despite a respectable advance, the index is just 2.1% up YTD, a poor performance compared to major US indexes. The Hang Seng Index (INDEXHANGSENG:.HSI) rose a dismal 1.9% in November and is up 2.9% YTD. Another Chinese stock barometer, the Shanghai Composite Index (SHA:000001) advanced 3.7% in November but is still in the red YTD.



Chinese equities advanced in Asia in the second half of November following news that the new leadership in Beijing is willing to undertake much needed reforms. Markets welcomed the news and set Chinese equities on a steady advance. But again, these corrections are nothing compared to the superb performance of US equities.

We have expressed our concerns about the “artificial” nature of rising American stock indexes several times this year and we continue to argue that it’s the FED and in particular the QE program that keep US equities rising. The problem is that once the FED stops easy credit, fundamentals will come back to play and current asset bubble is going to burst.

Based on some technical analysis tools, American investors got very complacent about ever rising US indexes. Take a look at the following two charts depicting the Dow. The top chart displays the actual index and its trading ranges. The fact of the matter is that the Dow is trading very comfortably in the middle range, close to the moving average, even at the 16,000 level. This suggests the index is not overbought, leaving plenty of room to additional upside. The second Dow chart displays a weekly performance of the index for the last six months. Based on the chart, the Dow rose for the 8th week in a row by the end of November. Sure the pace of advance slowed down but such a strong rally makes us nervous. The run up to the Santa Claus rally is really happening and it is bad news as far as we are concerned. A bubble is building and the earlier it burst the better we will be off.


Some point to an improving jobs market and for a reason. The US economy has been adding close to 200,000 non-farm jobs over the last few years. But as we just argued in the previous Newsletter (November issue) even current jobs creation is just making up for the deficit of jobs we built up in the 2008-2009 meltdown. In other words, the jobs market alone can’t be responsible for a Dow above 16,00. The housing sector is still recovering and so is consumer spending. Though current Black Friday may surprise investors to the upside…

All told, economic fundamentals don’t support current stock prices in our judgment. A lot more of our analysis is available in our previous Newsletter. This time we will focus on Chinese US listings instead.


We created an improved Chinese sector performance chart, adding market cap to it. Now we not only have performance but also weight as to which sector represents real investment opportunity. In this particular month, Chinese consumer non-cyclical stocks advanced the most as the chart on this page testifies. But the chart tells another story in addition. Chinese consumer non-cyclical sector is very tiny, only a handful of Chinese ADRs are in there. The close to 27% advance in November is attributed primarily to one stock, Synutra International (NASDAQ:SYUT). The problem is that even the largest component of the sector, Synutra (NASDAQ:SYUT) is only a company with market cap just over 500 million and trading volume is thin. Based on experience, this company is not considered investment grade by Chinavestor. Again, this is the “best” from the sector. So we argue that investors should disregard such a performance, at least for now.

The first “real” data is coming from the financial sector. Not only is the performance impressive, the sector is up 22.2% in November, but it has at least one quality listing: China Life Insurance (NYSE:LFC). This large cap, quality Chinese ADR lifted the sector and is worth paying attention to. We will revisit this stock in detail later in this Newsletter.

The third best set of stocks came from the transportation sector. Chinese airliners rose steadily while a railway and a shipping company weighed down the sector. Chinese airlines surged first in Hong Kong and that exuberance carried over to the NYSE. But that momentum has dried up and we don’t expect a lot more upside from China Eastern Airlines (NYSE:CEA) or China southern Airlines (NYSE:ZNH) for the rest of the year.

The healthcare sector is again small compared to the large energy or the services sector. Yet there is one company worth looking at closely: Mindray Medical Intl. (NYSE:MR). This Chinese medical equipment maker has solid cash flow, carries little debt load and solid profit growth. This is a stock value buyers may want to consider for the long haul. Based on technical indicators, a pull back in price may be an opportunity to buy.

Chinese energy stocks had a good month in November. Industry giant Petrochina Co. (NYSE:PTR), China’s largest oil producer, rose 5.1% setting a tone for the rest of the sector. Given that the stock is in the red for YTD, upside is not limited for the short term. Considering though that Exxon Mobile (NYSE:XOM) is trailing the Dow by a wide margin, it may not be time for energy stocks to shine yet.

Basic materials, services and technology stocks were all mixed and gave a dismal return in November.

Chinese utilities and Huaneng Power Int. (NYSE:HNP) in particular, remained weak in November. To understand what’s happening to Huaneng Power Int. (NYSE:HNP), investors have to roll back in time a few years. This company is the largest independent power producer in China and thus is a company of interest. But after a solid two year bull run from $15 to just under $50, the stock became overvalued. Since its short lived peak in May 2013, the stock price has been stabilizing in the $40 range.


Finally, let us revisit China Life Insurance (NYSE:LFC), the best performing large cap stock in November. Three consecutive trading days, November 15, 18 and 19 saw the price surging from the $40s to just under $50. Just as importantly, trading volume was three to seven times larger then average volume. This indicates strong money flows and suggests that the stock has more room left to advance. See supporting chart on this page.

Wish you successful investing,

Blaze Fabry.

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