New lows for Shanghai stock exchange spell selective profit opportunity

Posted August 13, 2008

The big Chinese companies that trade as ADRs, such as China Life Insurance Company Ltd. (NYSE:LFC), China Petroleum & Chemical Corp. (NYSE:SNP), and China Telecom Corporation Limited (NYSE:CHA) have declined at a far less precipitous clip than their home markets. Chinese solar stocks such as LDK Solar Co. (NYSE:LDK), China Sunergy Co. (NASDAQ:CSUN), and ReneSola Ltd. (NYSE:SOL) have actually risen in price as the Shanghai Stock Exchange is setting new lows. What can you expect? And where exactly can you still make money?

by J. Christoph Amberger

Baltimore — (TFN): Olympic medal counts look different to Americans than they look to the rest of the world. In the U.S., all medals count equally… and the team with the most gold, silver, and bronze medals “wins” in the standings. Elsewhere, it’s just the number of gold medals that determines who leads the pack. Which may explain why China feels its superiority complex validated with 17 gold medals (vs. the United States’ 10)… while Americans really couldn’t care less about leading with 29 (vs. 27) total medals.

Still, for a country who just put on the most expensive halftime show ever, with lip-synching girls, computer-generated fireworks, and thousands of young men in light-studded green “fruit suits” (as my teenage son called their skintight garbs), the stock market is sure looking like the last flea-bitten chihuahua in the pantry of a Korean short-order cook.

If China is leading in the medals count, the fruit suit optimism isn’t filtering through to investors. Both the Shanghai and Shenzhen Stock Exchange have simply plummeted since the August 8 side show. On Wednesday, the Shanghai Stock Exchange closed at 2,470 points, falling 135 points to close at a 20 month low after touching an even lower intra-day low of 2,372. The Shenzhen exchange slumped more than 6% to close at 698 points.

Let’s put that in perspective, shall we: Shanghai set an all-time record last October at 6,092. That’s a drop of 3,720 points in ten months. That’s a loss of 61% at today’s lows.

The last time I saw an index plummet like this was 1990, after Tokyo’s Nikkei had posted a record high at 38,912. The only difference: It took the Nikkei fully five years, until April 1995, to fall by this amount. China managed this in just 10 months.

Investors and traders are now accusing the government of causing the problem by misleading traders. (I’m glad this very Western tradition has finally made it to China…)

But here’s the odd part: There are some Western stock gurus who’re not worried.

In fact, one just came up with Six Reasons to Buy!

Let me summarize:

Reason to Buy China #1: The Silly Season Is Over. Now that the frenzy has subsided, real values are starting to show up again. The hot money has burned itself out, providing opportunities for those who see longer-term value and aren’t out to just flip a quick buck.

Reason to Buy China #2: Oil Is Coming Down. With oil backing off, China and India can breathe a little easier. The fear that high-priced oil might kill the Asian miracle is lifting. That gives them more time to tap alternative energy solutions and build economic strength at home.

Reason to Buy China #3: The Locals Are Optimistic. A recent survey from the Pew Research Center shows that most Chinese feel positive about where their country is headed. According to the survey, 86% are “content with the country’s direction.” (That’s up from just 25% six years ago.)

Reason to Buy China #4: The Growth Is Still There. China moves up the quality food chain. As China gets better at enforcing intellectual property laws, its high-tech skills will only increase… and profit margins, too.

Reason to Buy China #5: Personal Savings and Domestic Demand. Perhaps even more impressive than China’s long-term growth rate is the personal savings rate.

Reason to Buy China #6: Huge Foreign Reserves. China has somewhere between $2.3 trillion and $2.4 trillion in excess reserves.

Let me tell you why I am hesitant to wear that fruit suit of optimism:

#1: The “silly season” is over. If China managed to double and double again in two years on that supposedly “bad” hot money… where is the money coming from that will power the Shanghai to recover even 20%? Japan’s Nikkei has a cautionary tale to tell about markets that see the hot money born out. For the Nikkei, that meant a low of 7,831 in April 2003 — 80% below the record high.

For Shanghai, that would mean a level of 1,218 — another 50% drop. (Given the accelerated failure rate the Chinese, we could see this level within the next 16 months!)

#2: Oil may be coming down, relieving some pressure on wafer-thin Chinese margins. But labor cost — China’s biggest competitive edge — is going up. So are environmental regulations… healthcare cost (they say breathing the air in Chinese cities is the equivalent of smoking 3 packs of cigarettes a day)… and unemployment. Not good if cheap labor is what you’re known for.

#3: Local optimism. May I point out that the people are fickle, and consumer confidence the least reliable indicator of an economy’s health? More importantly, both people and investors are chafing with 60+% losses under their belts… and more to come!

#4: Growth will be there as long as Americans and Europeans place orders. Recession, anyone? Some analysts like to argue that the Asian economies have “decoupled” from the West. Someone must have forgotten to tell Japan… not to mention Europe.

#5: Personal savings and domestic demand. The latter may be there… and is usually a prelude to the destruction of the former. Plus, those personal savings have taken a beating since Chinese citizens transfered their renminbis from their passport savings to their stock brokers by the billion each week last year. Add in inflation and tally it all up once you account for two months of forced idling of factories and work forces, plus an overall low average income of just $2,025 a year (in 2006)… and those personal savings factor in far less than you might think.

#6: Huge foreign reserves may be more than made up by huge non-performing and “special interest” loans… a looming real estate crash… and of course the potential for the predicted devaluation of these reserves, most of which are kept in dollars. (May I also point out that Japan’s incredible foreign reserves did not help it one bit from 1990 to 2005.)

China is a potential train wreck in the making!

Analysts who predict armageddon for America based on a 20% drop in the Dow and discount a 60% drop in the Shanghai Stock Exchange may just have sand in their slide rules. Those who buy wholesale into official Chinese numbers and believe the U.S. government manipulates GDP numbers may not do their readers a favor.

The big Chinese companies that trade as ADRs, such as China Life Insurance Company Ltd. (NYSE:LFC), China Petroleum & Chemical Corp. (NYSE:SNP), and China Telecom Corporation Limited (NYSE:CHA) have declined at a far less precipitous clip than their home markets. Chinese solar stocks such as LDK Solar Co. (NYSE:LDK), China Sunergy Co. (NASDAQ:CSUN), and ReneSola Ltd. (NYSE:SOL) have actually risen in price as the Shanghai Exchange collapsed.

Then again, they move with their global industries… not with China.

But while I am getting more bearish on China’s medium- to long-term prospects by the day, I think there are a small number of Darn Good Stocks you can make some serious money with. At TFN’s Hot Stock Confidential, we’re currently pursuing a small company with key technology set to profit from big demand in China. This keystone technology will reach deep into China’s interior – tapping into its rural market and creating wealth on a scale like never before. This company has been earning between $80-$100 million a year on total revenues of $450-$550 million.

The company has just come back up from a bit of a dip, and is charging forward with gains of 8% in a day. We’re already up 20% over our recommended entry price, but you still can buy it for less than five bucks… and for an enormous upside!

In the coming months, we can expect broad asset sectors to take it on the chin. The only way to prevail and make money will be in leveraging the short-term stock price movements of solid, profitable companies. Companies you’ll find at TFN’s Hot Stock Confidential.