Hang Seng: Full Steam Ahead

It seems like China won't stop at anything to keep its economy running full steam ahead: China announced a massive $586 billion stimulus package. There they go again, China's cutting interest rates again to 5.58% (the 4th time in the last 10 weeks).

This brings me to the question: How do you tell if a market has actually bottomed?

In the last 100 years, there have been 4 comparable market disasters. They are the Great Depression of 1929, the 1973 Oil Crisis, the Nikkei crash of 1989-1990, and the Nasdaq Tech Bust of 2001.

The Facts:

During the Great Depression, the Dow PE went from 32.6 to 5 over 3 years. It was down for 18 years.

In the 1973 Oil Crisis, the S&P PE went from 23 to 12 over 2 years. It rebounded.

The Nikkei PE went from 78 to 28.47 over 3 years. It's been struggling downward for the last 2 decades.

The Nasdaq PE went from 264 to 58 over 2 years. It rebounded.

Present Condition:

USA: The S&P is down 52% off it's peak over 1 year and we're sitting at a forecast 2009 average PE ratio of around 11.9.

China: The Hang Seng peaked in November of last year at 31,638 and fell to 11,015 on October 28th and is now sitting at 13,846. I've got the Hang Seng PE located at 8.9.

A few considerations: You need to take into account are the Yuan/Dollar exchange rates and how the USA is funding a lot of this massive deficit thanks to our neighbors on the opposite side of the world. Also, when you compare the Hang Seng to the Nikkei above, notice that the PE ratio of the Nikkei only dropped to 28.47, which was still off the charts.

Analysis via Ben Graham:

P/E = (8.5 + 2G)

That's if you look at the Ben Graham equation. This implies that USA is going to grow faster over the next 5 years than China is. Likely? I don't think so.

That puts China's expected growth at 0.2%. Historically, ignoring the first year of this data series because it had unusually high PE ratios, the P/E ratio of the Hang Seng is about 15. The index is set to double. And that's just a reversion to the mean. Is the S&P set to double using this analysis? No way.

What would Buffett say if he realized that the only-child Chinese consumer is a lot more into spending as opposed to saving than his or her parents? Remember, Buffett doesn't just buy the index. When he buys companies, he gets good companies at great prices. So, he's not blindly buying American companies like the articles about him portray. Either way, I think Buffett will make money. I'm merely suggesting that he could be set to make more. He could buy Zhongpin (HOGS). That's an easy industry that even he would understand.

What companies do I like using this analysis in China? EJ, AOB, SOHU, and YGE. I expect to see growth stocks exploding back to their old PE ratios. My favorite companies have stocks that have fallen 80% or more and have stock fundamentals that have continued to explode and have no reason to stop growing as fast as they have been. I wrote this in reply to a technical analysis article that didn't have much substance.

Disclosure: I own EJ, AOB, SOHU, YGE.

Comments

[James Wilson:]

Many American Solar companys get their panels from YGE. lol

2008 Dec 08 08:53 AM

[omanmike:]

Wow, I've discover a fine, and competent analyst. I wasn't aware that one existed. I thought all analysts were idiots and incompetent. Keep up the good work. In my portfolio. my stocks are China Mobile CHL and Bombardier. I f I had to put all my into one stock, it would be CHL for reasons. that you mentioned.As for Bombardier, it is a fine Canadian company with a strong balance sheet, they just reported a strong third quarter, they investing appropately into the future, and they pay a small dividend. They are best in class in rail transportation and second in aerospace sectors. and in rail they are the number one in the world. And yet, to this day they are invisible to the American investors. When they are discovered, i think their stock will rise ten fold in five to eight years. Oh, did I mention, you are hedging your invstment to the coming drop of the American dollar. Smart people, such as Jim Rogers, are saying that the Ameriican dollar will drop so far down it wil be worth half the value of the Canadian dollar. They are certain the dollar will be worth about 10 cents compared to its present value, maybe.

2008 Dec 08 12:33 PM

[TTBF:]

Great info. Thanks. The one thing I would add, however, is that estimates (for US companies anyway) for next year are still being cut at a breakneck clip. Zacks has the estimate ratio (ratio of earnings estimate increases to decreases) at about .17 right now and still falling. A bit more than 4 estimate increases for every 25 estimate decreases. Ouch.

And this recession could easily last another couple years and get deeper. So the 11.9 figure you mention as the P/E based on next years earnings will likely move much higher in the months ahead. And the year after may see poor results from many companies as well if the recession is long-lasting.

2008 Dec 16 10:39 AM

[Zoltan L. K...:]

Even if P/Es stay low, there are sectors in which companys can enhance their earnings considerably. One of them is the internet in China, with a growing number of users. Companys with diversified offerings and small incomes from a large and growing customer base are well positioned. The internet might also offer cost saving opportunities for the masses. Sohu and a few other players seem to be diversified enough.

Jan 10 07:10 AM