Why I'm Long The China ETF

I bought 1500 shares of the iShares FTSE/Xinhua China 25 Index ETF (FXI) on the first trading day this year. So far, my loss is like a house down payment. However, I still like FXI. Here is why:

(1) Most people agree that FXI will be a winner again this year. I am just following the crowd. There are many reasons I need to follow this crowd. Globally, ASEAN and China will sport the biggest growth this year. North America and Europe are expected to grow by 2-3 %. In addition, Chinese currency is under pressure to appreciate.

(2) The primary reason FXI is under pressure here in New York is because our own market is unpredictable this year. Last year, the Dow retreated if the oil price went up. This year, the DOW retreats even if the oil price goes down. The Dow and S&P are just looking for a reason to go down. Under the circumstance, you need something that is going to go up.

(3) Most of arguments against FXI are incorrect. For example, some argue that Chinese stocks are overvalued in Shanghai. Therefore, in their view, it is overvalued in New York. Some people even use P/E ratio to support the argument. As a matter of fact, FXI includes the top 25 Chinese companies listed in Hong Kong. As for Shanghai, the overvaluation is created because of tight supply of equities of this state sponsored monopoly. The situation is similar in N.Y.; we don't have enough Chinese companies listed here. We need to share the returns of Chinese growth.

(4) The risks with investing in China have been over blown for decades. Without listing every one of them, suffice it to say that China has been growing at double digits at the same time. I will also point out that we don't have a standard metric to compare risks. Over stressing one at the cost of concealing others is not being honest with ourselves.

(5) International equity valuation is set globally. The trend is that Shanghai evaluation is going to drive up the Hong Kong valuation of FXI, and the Hong Kong valuation is going to drive up our valuation of FXI. This artificially depressed valuation will eventually hurt our own investment.

I have always enjoyed the opportunity of trading in the world's largest market. As a small time investor, I win with whomever wins. The Japanese have a similar view. Right now, they own all the important nuclear power equipment providers in the world. Japan stands to profit regardless who wins the nuclear power project. By investing in FXI and others, I hope this small time investor can share a piece of the global pie.

FXI 1-yr chart

Disclosure: Author is long FXI.

Comments

[Dave Malhotra:]

I want to address each of your points:

(1) Saying that China will grow this year is not in dispute. It helps when you have a currency which is artifically kept down low. The question is whether the 150% gain in the Shanghai Composite Index since 2006 is a fair valuation of that growth or if it reeks of rampant speculation. Following the crowd as you say can work for a while in a bubble but when the panic sets in you will not be able to hit "sell" fast enough.

(2) This is absolutely wrong. FXI trades a few percentage points above or below its NAV. Its NAV is determined by the prices of the assets which are listed on the HK exchange.

(3) The A shares in China are in a bubble with P/Es hovering around 40. The H shares in Hong Kong while probably not in a bubble, per se, are to most observers overpriced. ADRs traded on the US exchanges are cheaper than the H or A shares and are probably more fairly valued. FXI is an index of H share companies. Therefore FXI is overpriced.

(4) The risks have been overblown!?!? This is clearly incorrect. Look at this chart of the SSE Composite Index:
finance.yahoo.com/q/bc...;t=my&l=on&...

That is alot of volatility. You better believe investing in China is risky.

(5) Like was mentioned in (2), FXI trades at a small premium/discount to its NAV. The NAV is determined by the price the H shares. Your point is a false one. And the idea that the Shanghai valuation will pull up the Hong Kong valuation is going to be wrong. In Shanghai the market is driven by retail investors caught up in a mania. In Hong Kong the market is dominated by institutions and professionals.

That being said FXI will need to correct in the short-term before it can begin going up again. It has corrected 11% from its 118 high but more downside is likely. I am not arguing that it is not a good long-term investment but this is by far not the optimal entry point. The price has gotten way ahead of the fundamentals (which are very good).

2007 Jan 28 09:10 PM

[Daniel Su:]

I speak English, Korean, and Chinese. End of December, I watched Chinese news program which featured a story about 70 year old lady who was hit by truck, so the police tried to call the ambulance, but she insisted that she did not need ambulance service, because she urgently needed to get to brokerage house to purchase stocks. People massively withdrew their life savings to purchase stocks especially low price, speculative stocks. People waiting in line four to five hours in the brokerage houses to open accounts, people quit their regular jobs, and huddle around price quote TV screens in the brokerage houses. Sounds familiar? US 2000 Tech bubble is repeating in China right now. No gurantee how long this rally will continue, but my expectation is that a lot of small companies will go under with people's life savings.

Famous quote by Jesse Livermore: "When the shoeshine boy gives me stock tips, I know the stock market has topped."

2007 Jan 29 01:07 AM

[Saul Sterman:]

I thought Joe Kennedy said that. Are you sure it's Livermore?

2007 Jan 29 08:28 AM

[Daniel Su:]

You are right, I did internet search and USA today quoted Joe Kennedy. Thank you for your information.

2007 Jan 30 12:33 AM