Chinese Economy Humming Along; Stocks Still Raise Concern

by: Shaun Rein

A few years ago I wrote a column for BusinessWeek entitled “Invest in China, Not Chinese Companies”. The main thrust of the article was that everyday retail investors who cannot risk losing money should not invest in Chinese companies because of their lack of transparency and the volatility of the market.

The last few months, Chinese stocks like a Baidu (NASDAQ:BIDU) or LDK (NYSE:LDK) have gyrated, with double-digit gains and losses the norm. Just this week we saw Focus Media (NASDAQ:FMCN), one of my favorite stocks, collapse just under 30% in one day. I argued they should invest in American companies that are doing well in China like Starwood Hotels (HOT) or YUM Brands (NYSE:YUM).

I have gotten a lot of responses to my recent Seeking Alpha piece, “Select Chinese Stocks Have a Way to Go, where I put down my equity portfolio of Ctrip (NASDAQ:CTRP), Focus Media (FMCN), China Mobile (NYSE:CHL), Google (NASDAQ:GOOG), and Goldman Sachs (NYSE:GS). People have asked what I am doing now and what I suggest after Focus’ drop.

So I thought I would tell you where I stand with my holdings and what I am thinking now for people who have a higher appetite for risk. First off, my equity holdings are actually a fairly small part of my total assets currently because I have sold out regularly since January 2007. In the past year, my cash holdings have taken up between 40% and 70% of total assets. I have held Australian dollars, Euros, RMB, and Hong Kong dollars.

I also am an angel investor in companies in China and am now looking to buy real estate in the US. I doubt I will ever be able to call the bottom of the market in the US, so I figure I might as well start looking now in areas with potential for growth long term.

As for my equity portfolio— I have made some changes. I sold out all my Google and Goldman, stupidly, before Goldman announced better than expected numbers yesterday because I was gravely concerned about the health of our banking system and wanted to be out of financial stocks. I also made the mistake not to buy heavily into Focus Media after it dropped, like I did with Ctrip last autumn. I should have bought more Focus because I believe in the stock and the results Tuesday night proved me right.

So right now, I am only in 3 stocks: China Mobile (CHL), Ctrip and Focus Media. Now Ctrip and Focus are actually taken up a larger portion of my portfolio than they did last week. I feel comfortable with this.

The fact of the matter is that the Chinese economy is humming along just fine. The A-Share market has dropped and Chinese investors have been fairly mature in how they take it – we do not see the same panic and fear about the Chinese economy’s strength as we see in the States. This makes me even more confident that buying Chinese companies that target the middle class here is the way to go – they are still spending and the economy will boom regardless of the stock market because so many consumers are completely shielded from day-to-day gyrations of the Chinese market.

However, I still have some major concerns about Chinese stocks in general… even the ones I own:

  1. Market caps are still fairly small for most Chinese internet stocks, meaning that hedge funds control significant chunks of the company. Thus, stocks are highly vulnerable to the whims of their hedge fund owners. When someone gets spooked by rumors, or if hedge funds are having credit crunches and need to unload shares to raise capital, these funds might press the “sell” button and the stock could spiral downward. Thus, even if a stock should be high, the behavior of a few hedge funds could beat it down.
  2. Wall Street analysts and reporters for some reason keep moving markets even if they have no idea what is going on. Fear blew into Focus because of rumors that they were losing a license on SMS. I am still not sure that they have the license, or even need it. Even if they did lose something, Focus is diversified enough not to drop 30% on one day. Come on guys. It is not like Linktone (NASDAQ:LTON) or Kongzhong (KONG).

Last year I had a conversation with a stock analyst from one of the big houses. This analyst told me that her boss – who was famous for covering Baidu – could not even figure out how to get onto the Baidu website because he thought it was the stocker ticker address… i.e. Do you really want to listen to the advice of people like this?

All in all, the past week has not been a great one for my holdings. It should have been if I had continued to add into my top stocks like Focus and Goldman when the prices went down but alas I did not, as I was concerned about the equity markets. I should have listened to my own advice better – back the companies with good management, cash flow, and scalability and disregard day to day fluctuations.

China Market Research Group (CMR) Managing Director Jessica Lo, CFA and CMR Analyst Charlotte MacAusland contributed to this article.

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