How to Think About China Stocks

Vitaliy Katsenelson has a skeptical piece on China’s economic “miracle” at MSN Money. As we pointed out earlier this month, skepticism has never been a strong suit of the Raging China Bulls and it’s refreshing to hear intelligent, contrarian voices like Vitaliy on the investment side or Derek Scissors for a broader economic/political view.

But there’s a fine line between intelligent skepticism and completely missing out on a gigantic investment opportunity for the sake of your beliefs. Like Vitaliy, I used to be a China skeptic. A couple years ago I published a scathing critique of the iShares China fund (ticker: FXI) at Forbes.com.

While I stand by my reasoning to this day, it was the wrong call. Period. And it was one of the worst I’ve ever made. After I had told the whole world that FXI was a dog, the fund rose in pretty much a straight line for more than a year. By October 2007 it had tripled. I was the laughing stock of the message boards. I suppose I was ultimately vindicated in some sense last fall, but that was only because, you know, the world almost came to an end. Other than that, it worked out just fine.

I’m still skeptical about parts of the China investment case, and I still think that FXI is a lousy way to invest in China even if you are bullish. But I also recognize that there are a lot of different ways to think about China as an investment theme and that dismissing the whole thing as “unsustainable” only guarantees that I’ll probably miss out on some great ideas. I like being a contrarian, but I like making money a lot more.

Bottom line: A lot of the things that you hear about China might be full of hype and hooey, but at the end of the day, China is the real deal. It’s up to you to figure out how it fits into your portfolio.

Comments

[Alan Young:]

I agree. And since you didn't elaborate on the many "different ways" to approach China, I'll take the liberty of getting the ball rolling.

In 2007, the story was exports. Last year, that crashed, but left some good opportunities in the consumer and finance sectors. Now, infrastructure is the big story. If you only know one ETF, you're missing most of the story.

China is a big and complicated place, and there's no more reason to lump it together and call it a good [or poor] investment than to think that, say, Europe is a good [or poor] investment, without regard to stock selection, timing, sector rotation, and all the other alpha-creation and risk-reduction techniques available.

May 21 04:08 AM

[Mad Hedge F...:]

This is a top pick for me. Investors which took my New Year advice to load up on emerging markets are now facing the vexing problem of what to do with all of their new found wealth. The emerging market ETF has soared by 57% to $33, and two of my favorites, the China ETF and India ETF’s, have doubled from their bottoms. The average emerging stock market is now up 50% on the year. The good news is that I believe this is just the down payment on a multiyear, tenfold move for many of these markets. The bad news is that all of these markets are way overbought on a short term and technical basis, and that we have to expect pullbacks this summer that could give up as much as half of the recent move. If you are a trader, take the money and run. If you are a long term investor, no pain no gain. But I don’t think any of these high growth plays are going to revisit the 2008 lows. Those were once in a century bottoms. This is the only long equity exposure you should have for the next decade.

May 21 07:57 AM

[huangjin:]

Chinese SOEs are like the U.S. automakers and banks. They even use roughly the same method to move the wealth of the people onto the balance sheets of government owned companies: "loans" that never have to be repaid.

May 21 08:47 AM

[Albert Meyer:]

PTR, CHL, YZC, ACH...

May 21 09:46 AM

[Danny Furman:]

Well written article, thanks John. I entirely agree that ETFs are no way to invest in China (large caps have already established strong valuations), however for EMs like India and Korea they are the way to go. Dozens of profitable, growing China smallcaps trade way below book value. My favorites include MYST.OB, ALIF.OB, LPIH.OB, CNEH.OB, CYXN.OB, OPAI.OB... If you have fairly high pain tolerance these are intriguing long term plays.

May 21 10:15 AM

[Alphameister:]

Rare to find such humility and crow-eating on this site, and I commend you for admitting error and moving on. I own a slew of small-cap and micro-cap Chinese stocks, and I agree with D. Furman that opportunities are much greater in these sectors than with an ETF such as FXI (though it should do well also). I'm buying TSTC at current levels (around $2.50) and have large stakes in APWR, CSR, LTON, PWRD and WH, all of which have had good runs but are correcting today to become candidates for new purchases. Also check out SORL and SUTR which I'm eyeing for purchase after previously having taken big profits.

May 21 01:04 PM

[ArtfulDodger:]

John Christy:

You wrote: "A lot of the things that you hear about China might be full of hype and hooey..."

Indeed, a lot of the things you hear about any and every market are full of hype and hooey! That's the heart of the beast speaking.

Every up market is never going to stop going up; every down market is never going to stop going down. Both are a lot of hype and hooey.

This is why markets always overact, but it doesn't mean by any means we can't invest in them and make money—especially if we can discipline ourselves to ignore the hype and hooey, except to go against it when it gets to a fire point.

I've sold off some of my China investments this week, but I still own several.

May 21 02:47 PM

[Alphameister:]

Agree with ArtfulDodger. I sold and trimmed Chinese positions this week that I expect to double in price within a year or two of the time I sold them. The most undervalued stocks don't reach fair value in a straight line. Incidentally, LTON, which I first mentioned buying below $1.30 and is now $1.90, has about $2.25 in cash with profitable operations likely to add to that amount (which is probably why LTON is holding up so well in the face of today's sell-off).

May 21 03:03 PM

[ArtfulDodger:]

Alphameister:

Thank you for the info re LTON; will check it out more closely. AD

May 21 03:12 PM

[beijingpaddy:]

I think Chinese large caps are the safest bet for the more conservative long term investor. These Chinese large caps are backed by the full faith and credit of the richest government in the world. And will most likely be so for the foreseeable future. Gone are the days of Zhu Rongji’s plan to take these SOEs private to fund the state’s pension liability, among other things. The current administration is a lot more public orientated (in the socialistic meaning of the term) than private. I like those SOEs that are the largest in their particular sector. Many of these firms stand a very good chance of becoming the largest in their global sector and not just China in the following years. And they are still bargains. Just imagine buying for a few USD a stock that very well could be selling for hundreds 10 years from now. It is probable and not just possible.

You can purchase many of these directly on the HK Exchange via E*Trade’s Global Trading Platform. The HK exchange price is mostly at a discount to the NYSE price if they are traded there, and usually less expensive than Shanghai too, if you have a way to buy on that exchange. I like HK exchange traded plays for lots of reasons.

Do your homework though. Because China is socialist, changes in government policy can have a bigger impact on your holdings than in more market economies.

Buying Chinese stocks today must be similar to what it was like for British investors to buy into the US growth story at its beginning 100 years ago. Deals like this don’t come around all that often.

May 22 01:05 AM

[ArtfulDodger:]

Bejingpaddy:

You wrote: "I think Chinese large caps are the safest bet for the more conservative long term investor. These Chinese large caps are backed by the full faith and credit of the richest government in the world. And will most likely be so for the foreseeable future."

And:
"Buying Chinese stocks today must be similar to what it was like for British investors to buy into the US growth story at its beginning 100 years ago. Deals like this don’t come around all that often."

Well said. My views exactly.

Investing through HG into China is an opportunity of a lifetime.

Many American investors are leery because of years of propaganda against a Communist Regime that no longer acts like one.

Oligarchic, yes. But more nationalist than anything. Which means the government is statist, but also at this time pro-business.

Is America not statist? And can we say that America is still pro-business under the current leadership? I don’t think so.

It’s obvious that China wants its entire population of 1.1b people to take part in the economy and is working toward that end; that is an investing opportunity of more than a lifetime. Investors ought to take note of it.

I see one potential, but small worry: a regime change that would take the nation back toward complete state ownership—but my contact there says there’s nothing of the like on the horizon.

Both Jim Rogers and John Rutledge see things the same way, and they're no small-minded peons.

Long several Chinese stocks.

May 23 05:05 PM