Thoughts on China

Its been a long time since I wrote about China. I was very much invested in the Chinese equities in 2009 and the first few months of 2010, but lately, sensing that there is just too much negative sentiment affecting this emerging market, I exited most of my China positions with just a few exceptions. I still trade around the news and earnings, as well as some special situations in Chinese US listed stocks, but this has been a smaller part of my investment theme this year.

The EM (emerging markets)investing has fallen out of favor in general, clobbering many of the Chinese stocks, as de-risking has once again becoming an overused investment term de jour. At the same time, I think the market seems to completely over react to the headlines coming out of China.

But there is a number of prevailing themes that have been been the main cause of the negative sentiment towards Chinese investments.

1) China's growth is slowing and they will less commodities, fewer cars, agricultural equipment. China's slowing growth will subtract from the global growth.
2) China's Real Estate bubble will soon burst, taking down their economy.
3) China's will stop investing in Europe, US, treasuries, buy commodities, etc, etc, etc.
4) China's bank lending is slowing, as the new reserve requirements and changes to lending practices will close access to capital.
5) China's inflation is creeping in, expect to see more tightening measures and policies. Will China devalue its currency?

There are many more themes and sub-themes and variations of the issues listed above, but they all have something to do with these five main concerns.
Well, to a certain extent, these concerns are valid. BUT....

1) Yes, China's growth may indeed slow down, from a robust 11-12% pace, but even with a 7%-9% annual growth, their economy will be the fastest growing of all the major world economies. The issues impacting eurozone will have some effect on Chinese economy, so it would be best to focus on companies that derive most of its revenue from a rapid increases in domestic consumption, rather than goods made to export.

2) Its a well known fact that every company in China has at least two sets of books. In some cases three or more. Well, the Chinese government undoubtedly, has more than one set of economic indicators. One they use to make policy decisions, and another on to report to the world. One needs to be careful not only interpreting the indicators coming out of China, but also, trying to figure out how far off is the published number from the the 'real' one. One needs to remember, that Chinese government is most concerned with maintaining the social stability and harmony, so don't expect to see any frightening economic statistics coming out of China. This of course bring in question everything that being reported by the Chinese companies, but that is why they get the low multiples that they get.

3) China will do what is best for China. The economy continues to chug along and they will continue to have an insatiable appetite for commodities. they will also continue to manipulate the markets to their benefit. If it means that they need to deplete some of their reserves to put pressure on the commodities prices then...draw your own conclusions.

3) The real estate bubble in China is much different than what we had in US. Most of the real estate speculation is concentrated in the tier 1 cities, like Shanghai, Beijing, and Shenzhen. The tier 2 and 3 cities also have seen their share of price increases, but nowhere close to bubble territory. Actually, the policies that Chinese are implementing to cool off some of the real estate speculation are good and should help in the short.medium term to stabilize the prices and remove the fear of bubble bursting. Keep in mind, that Chinese, unlike the rest of the developed world, still use mostly cash to finance their RE purchases, so even if the bubble does burst, the effect will be a lot more contained.

4) By now, everyone realizes that the valuations in the A-share market are artificially high, since there are very few investing opportunities available to mainland based Chinese investors. The Chinese companies listed in US, generally have more reasonable valuations, especially if you consider the balance sheets, which have decent amount of cash from recent funding transactions. stock growing 20-25% per year organically, with a 10-25% of market cap in net cash and trading in mid single digit PE.

5) China'a PMI declining is actually a good thing. Why? Because it means that the fear of a run away inflation in China brought on by the over expansion (thanks to the liberal lending practices and government stimulus programs over the last 12 months) is probably misplaced and there will be far less need for Chinese to tinker with with their economic policies.

For now I am watching carefully, as the trader in me says to sit tight and wait for the freight train to pass by. But the other little voice of a contrarian investor in me tells me to start looking for ways to play the multi-year secular investing theme that is China.

Here are some of the few names on my radar: CVVT,HRBN,PUDA,TRIT,YUII,CTEL,YONG,ASIA,GFRE.