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Timing China's Stock Turnaround

|Includes: China Mobile Limited (CHL)
What is pressuring China stock prices? Popular media like the New York Times routinely print articles pointing to a slowdown in the Chinese economy. "China Slowdown" stories do seem to be the flavor of the month, but they are both misleading and not the least bit helpful to investors.

There's no doubt that Chinese stocks, and ADRs which trade like Chinese stocks in the U.S., have come under pressure in recent months. But the downturn doesn't stem from an economic slowdown in China. In fact, Chinese stocks have become very cheap and it's just a matter of time until they enjoy another turnaround.

BNY Mellon China ADR Index: Year-to-Date

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ADRs traded in the U.S. were flying high until they were hit by the six-week downturn which hit every sector of the market. Fundamentals don't make much difference in a market-wide downturn like the one we experienced in May and early June.

Consider for example a tremendous company like China Mobile (NYSE:CHL). As China's largest telecom carrier, China Mobile generates an excellent dividend yield of 4.34 percent. The company has a market cap of almost $180 billion and a very cheap P/E multiple of 9.82. With hundreds of millions of subscribers and the numbers rising daily, China Mobile is actually getting cheaper as its business grows. Remarkably, it is currently trading near its 52-week low.

As Jim O'Neill, chairman of Goldman Sachs Asset Management, said in St. Petersburg recently, investor fears about China and the other BRIC countries are overblown.

It was O'Neill who invented the term BRIC to represent the fast-growing economies of the world's new emerging powers: Brazil, Russia, India and China. Speaking to Reuters, O'Neill advised investors, "For those who have a little bit of foresight, it gives them the chance to get in at sensible levels."

He added, "China and Russia are both looking quite interesting because they are cheap."

The View From China

Different concerns are ratcheting up the pressure on traders in Shanghai. In fact, Chinese stocks traded in Shanghai and Shenzhen have fallen to their lowest level in nine months.

The Shanghai Composite Index slumped 14 percent this year from its high point on April 18th.

Shanghai Composite Index: Year-to-Date

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But it's not an economic slowdown that causing Shanghai to slump. It is China's ongoing monetary tightening.

The central bank has boosted bank reserve requirements twelve times and interest rates four times since the start of last year in an effort to cool inflation and damp down rising housing prices.

There are encouraging signs that housing price increases are beginning to ease off. On Sunday, Beijing reported that new home prices declined from a month ago in nine cities. Prices remained unchanged in eleven cities. Twenty-seven cities reported lower monthly price increases according to the National Bureau of Statistics.

But there are also indications that the next round of inflation figures will come in at an unacceptably high six percent. That would almost certainly spark another round of interest and reserve rate increases which will put pressure on Chinese stocks one more time.

The turnaround will come when it is clear that the government is through with its policy of raising interest rates, and when there are clear signs that the inflationary trends will reverse.

Western stock markets face entirely different pressures related to chronically slow economic growth and unsustainable debt levels. Until debt issues in Europe and the U.S. are resolved, they will continue to be a specter that shadows western stock markets.

So, yes, China's economy is slowing down. That's exactly what Beijing wants as it struggles with inflation. But growth will continue in the eight to nine percent range for the remainder of 2011 according to almost every available source.

As Jim O'Neill put it so well, "The long-term trend is for the BRIC economies and the BRIC investment theme to continue to be the dominant themes of our generation."

It is just a matter of time until markets again reflect this macro-trend.


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