Josh Stern

Why I'm Worried About China

In earnings reported over the last two months, results from domestic focused Chinese companies are holding up a lot better than the overall market while the stocks are doing a lot worse than the overall market - a good percentage are posting huge year on year gains while the stocks are down 50-90% and trading at outrageouly low valuation levels relative to trailing earnings/sales/cash flow/liquid assets. At the same time, many domestic facing Chinese companies reported blowout earnings, though many also cautioned about a sudden demand drop in October that clouded near term forecasts. From everything I've read, the lack of bank lines of credit for importers continues to be a huge problem for international trade and hurts Chinese exporters and manufacturers. At the same time, this factor is presumably temporary and causes indices like the Baltic Dry to severely underestimate even current low cyclical end demand for dry bulk shipping.

Taking all of the above together, I see the category of being a domestic facing Chinese company as currently a big investment plus when looked at purely from a macro POV. Bears counter that they think fraud is much more widespread. I don't see fraud as being plausibly common enough to come anywhere close to making up the huge discount in valuations these companies are getting now. I'd suggest instead that they deserve some discount because the immature investment culture tends to result in mgmt. that sees investors as more of a source of potential/past funding and less like actual owners of the company. As a result, I don't see valuations getting to par until dividend paying, share buybacks, and corporate buyouts become much more common than they are at present. But valuations are so compressed that Chinese companies still represent excellent opportunity for investors with longer time horizons.