Are China Stocks Headed Higher?
One of the big stories in 2010 has been the lackluster performance of China stocks. For an economy that is projected to grow by greater than 8% this year the underperformance is surprising. But a rising swell of bad publicity and bubble chatter has made many investors wary of buying into China stocks over the last couple of months.
But last week that began to change, at least in the short-term. Last week the Shanghai Composite index rose 3.2% as investors began to show interest in China stocks again. It could be that some mutual funds are beginning to add modest positions after a net outflow from China-oriented equity funds that Bloomberg put at $1.2 billion for the quarter ended March 31.
As I've discussed in previous issues of Small Cap Investor Daily, the rash of negative events (and associated press coverage) impacting U.S. - China relations in 2010 has not helped many China stocks. Both the political and business relationships between the two countries had been growing increasingly antagonistic.
A chilly business climate ensued when China was called out on protectionist measures that favor homegrown industries. Beijing adopted this policy to help China industries move up the value chain to better compete with foreign companies, rather than continue to be sources of low cost (and low value-added) components. Add in a splash of U.S. arms sales to Taiwan, a pinch of censorship (also known as the Google debacle), a dash of inflated China real estate prices, and a little currency manipulation by Beijing and you have a recipe for stock price devaluation.
This is exactly what has been happening, as evidenced by the lackluster 2010 performance of many China stocks. In fact, the iShares MSCI Emerging Markets ETF (NYSE: EEM), which tracks the performance in all emerging markets, has underperformed the Standard and Poor 500 so far this year. China isn't the only emerging market to lag.
But last week may well mark a turnaround to this consolidation pattern. After a decline of nearly 12% in the Shanghai Composite Index that began on December 7 of 2009 and reached a low in early February 2010, last week's 3.2% rise in the index was a welcome relief for investors. And in yesterday's trading session in the U.S., many China stocks in the Small Cap Investor PRO portfolio traded sharply higher with gains reaching 7%.
***The big development is that it finally looks as though U.S. - China relations are becoming more conciliatory, an appropriate tone for countries that want to have a future working together. Most notably, Beijing seems to be open to discussions to let the yuan move higher. The move seems probable enough that the U.S. Treasury has delayed a report that most likely would have accused Beijing of manipulating the yuan to keep it pegged to the U.S. dollar.
If this happens it would be a remarkable development, as China is not prone to acquiescing. In fact, it tends to get more stubborn in the face of political or economic pressure. The rhetoric from the two sides isn't necessarily going to result in immediate change, but it is certainly a step in the right direction.
And as I said before, China stocks are starting to move in the right direction on the news. Take a look at the one year chart of the Shanghai Composite Index below and you can clearly see the jump higher last week as the index exploded out of its previous range between 2,900 and 3,100.
As you know, I've been very bullish on certain sectors in China. But, thus far in 2010 that bullishness has yet to pay off. But the year is still young, and as I wrote last week we're not going to jump ship on our China investment thesis quite yet. I have had a strategy of investing alongside the Chinese government to take advantage of economic stimulus spending, as well as adding high growth (and undervalued) stocks that sell products and services that will help China advance social and economic goals.
I don't always expect to make money on day one with our small cap investments. And I've been at this long enough to know that it's impossible to perfectly time every stock purchase.
But for investors looking to stay invested in China, now more than ever it is absolutely critical to focus on solid companies with strong earnings and above average growth. It is also important to be looking at consumer and retail plays, as these sectors will tend to do well as the people of China enjoy a rising standard of living. The recent pop may provide an opportunity to rotate out of some more speculative emerging market positions, and begin to buy into more conservative positions.
We'll continue to look for opportunities in China, and other emerging markets for that matter. This is no time to get giddy with excitement that emerging markets are going to post another 70% rise like in 2009. But there do appear to be signs that U.S. - China relations are thawing. And that could mean its time to dip a toe back into select China stocks.
