US Market Volatility a Boon to Chinese Stocks

Last week’s volatility in the US market provided a boon for investors in Chinese stocks with strong fundamentals that focus on selling to China’s rising middle class.

Shares of these companies also all dropped last week as American investors fled the markets. The normally irrational Chinese investors in A-shares were correct in staying in the market for the reasons I outlined when I was interviewed last week by Reinhardt Krause from Investor’s Business Daily.

But I am glad that investors got nervous, as it was a good opportunity for our hedge fund and mutual fund clients (and me) to buy in. At the end of the day, although the world’s economy is more integrated than in years past, Chinese consumers are insulated from many of the bumps in the world’s capital markets because their financial sophistication is relatively low. For companies with strong business fundamentals like Ctrip (CTRP) or China Mobile (CHL), that means their revenues are going to continue unabated. Investors should take note and not flee companies that have strong corporate governance – i.e. companies whose numbers you can trust as legitimate – and whose businesses are based on sustainable business lines.

An 18-year old teenager in Shanghai is still going to eat out in restaurants and play online games from companies like Netease (NTES) and The9 (NCTY), regardless of the tumult smacking sub-prime lenders like Countrywide (CFC). His salary will top out at several hundred dollars a month, and he will not feel the ache of worsening investment conditions because he probably does not have any investments that dropped in value. Parents are still going to send their children to New Oriental (EDU) for English or test preparation training. Young female works are still going to buy Gucci bags or L’Oreal cosmetics (LRLCY).

The fundamentals are still there for Chinese stocks that focus on Chinese consumers. I sent out a note to many of our hedge fund clients to go back into the market, and I did so personally with my own money. I bought more shares of Netease (NTES), Ctrip, Focus Media (FMCN), and FXI (FXI) as these companies unfairly dropped because of American liquidity concerns. For some, I would look to see if the valuations are justifiable long-term but in the short-term they are.

Going forward, all of these companies have room to grow because they are hitting consumers who are continuing to spend. As many of you know, Ctrip is one of my all-time favorites as Chinese continue to travel both on the business and leisure angles. Some analysts say that you should buy Ctrip because of foreigners coming to China for the Olympics. Those statements are ridiculous because tourists just arriving in China will most likely have already booked their hotels and plane tickets. But the Chinese are continuing to travel and that combined with a great management team is what makes Ctrip a great bet.

Netease is near its 52-week low but will bounce back. The stickiness factor amongst its users is too good. It is one of the few well-run Chinese internet companies whose share price is cheap. I see it as becoming one of the bigger bounce backs of the year.

China is not a place to invest for retail investors who cannot take volatility as I mentioned in BusinessWeek last year. But for those that are willing to deal with a few bumps in the road, focus on the companies that have fundamentally strong business plans and which target China’s emerging middle class.

CMR analyst Charlotte MacAusland contributed to this article.

Comments

[Sheengem Gao]

Do not expect Netease will do any better at once because right now in China its performance is pretty poor compared with other dotcoms. My friends told me that its online game is not as attrctive as I guessed. Personally I don't like the Tianxia2 it recently launched and its email service and the 163 website. China's Internet place are getting ferociously hot as more and more foreign companies squeeze in, Netease is facing daunting challenges.
However I am looking forward its recovery.

[Chimin Sang]

Shaun, I am glad to see you are long in FMCN.