A Harsh Reality
Seeking Alpha Analyst Since 2010
How does this sound for a tough environment?
- The economy is slowing as the government goes into extreme fiscal tightening measures
- Economists are lowering GDP growth forecasts for 2011
- The Government starts to publicly admit inflation could stay around 5% for the foreseeable future.
- Commodities prices are dropping on perceptions demand is slowing
- The major market index has been down 5 of the last 6 days, and is near a 2011 low
- Every company in the small stock sector of this investment theme is priced as if their numbers were fraudulent
- Not one fund manager will touch any of the stocks in this sector
Unfortunately folks, that is a pretty good overview of the state of the US listed China small cap stocks today.
Here's a chart I show you nearly every week. It's the Shanghai "A" shares- China's version of our S&P 550:
As you can see, the "Macro" perception of the Chinese situation looks bad. The Shanghai "A" shares- in my view, the best indicator of how the Chinese feel about their own companies, has been in a bit of a free fall of late, and is approaching the January low of about 2800.
So, is this going to be a tough place to make money in the very near future? The short answer is yes- and I believe there are only a few names to own/watch, and you shouldn't be overly invested in those names at this time.
I am extremely sensitive to this responsibility/obligation. You are a subscriber, and have invested good money for a service. This is the EmergingChinaStocks newsletter, so you're expecting ideas within that theme.
One of my obligations to you valued readers is to gauge the environment and help you understand where we are in the cycles. I don't want us over invested when there's little chance for reward. No punches pulled- globally, seasonally, sector wise, we're in a Bear Market for small cap China stocks.
Here's the good news, and I've been thinking about this a lot. Vast fortunes are made in environments like this.
In 1987 I was a sitting in front of a quote machine when the DOW dropped 500 points in one day. In 2000 I watched the dot coms melt down. In 2001 I watched the market crash in the 911 terrorist attacks. In 2001 to 2003 I followed the WorldCom/Enron/Tyco disasters. In 2008 I watched the market get decimated as the wide spread perception was our financial system would completely melt down thanks to sub prime lending.
All of these major market blood baths had two things in common- first, they were all precipitated by some sort of crisis. Second, they all ended up being fantastic buying opportunities if you identified the right companies. No one would touch an equity and all the rhetoric out of the medial, create the best opportunities.
The China Small Cap sector is no different today than of the aforementioned disasters. People tell me its different this time because they are all crooks. Wrong. Not every China based company is committing fraud, and many of them have very valuable and highly profitable businesses. It's just popular to look at them that way in today's environment. When everyone hates something, I know we are near a bottom.
There are going to be some monster wins coming out of this bloodbath, and I'm going to find a few of them for you.
I have taken the time to educate myself and learned a lot in the past 30 days. I have no intention of getting caught on the wrong end of another March of 2011.
Here's how I plan to do it:
Alan Rifkin and China 360I believe I have a really good understanding of the problems that plague the China small cap sector today. The market is vilifying the managements of these companies, but I as I've become more educated on the history and the culture, I believe I have a better understanding of the challenges.
Certainly there are some crooked characters taking advantage of US investors and their relative immunity from the consequences of their behavior.
However, we have to look at from the China CEO's point of view as well. There have been numerous private equity funds, investment banking firms, and merchant bankers running around China with wide open check books and very poor due diligence practices.
The Chinese CEO is relationship oriented. The financier is transaction oriented. These financing sources are doing a very poor job explaining the need to abandon the "Business as Usual" mentality of China, and fully and completely adopt GAAP accounting practices. Once the Chinese CEO gets his money, he goes back to running his company like it's still private, violating all sorts of GAAP standards that might include making undocumented loans between companies and/or friends, and any number of other infractions. The transaction guy is no longer anywhere to be found. He's on to the next deal.
My new advisor, Alan Rifkin, has taught me a lot of these practices don't diminish the value and profitability of the business, but they do violate GAAP accounting standards, and make the auditors very uncomfortable as these shenanigans are uncovered. They are business as usual in China, but not in the US.
The key- invest in companies with very strong CFOs that are intimately involved in the day to day operations, and enforce strict GAAP accounting standards.
Here's your homework assignment. If you really want to understand what's going on these Chinese companies, read Thornhill Capital's two most recent newsletters- particularly the June edition. You'll find them on my home page on the left hand menu bar. Here's your short cuts:
Thornhill Capital April Newsletter
Thornhill Capital June Newsletter
China 360 is a service offered by Thornhill Capital. CEO Alan Rifkin has been doing extensive consulting due diligence work in China for the last 10 years, and he has a team of 20 China born forensic accountants available to go anywhere in China on a moment's notice.
Alan and I are discussing several companies that could be good targets for investigations. I'm looking for situations where we can disprove allegations by short sellers, and take large positions in very cheap stocks. I'm going to pay for this service out of my own pocket.
I'll go into more detail as opportunities unfold. I'm doing this to protect you and find some stocks I can really get behind.
As I pointed out earlier, there's a fortune to be made with the right companies- and I plan to find the right companies.
Update on My Big 3To review the few China small caps I still recommending, you will have to sign up for a trial subscription. The first two weeks are free.
At this time, I only have one strong buy recommendation on a China small cap stock. Microsoft (X-Box), Sony (PSP), and Nintendo (WI) all have motion video gaming systems that are very popular in the US.
Were you aware none of those systems is available in China? The Chinese government has not licensed them for sale. I've identified a China small cap that has a relatively new motion gaming platform that is growing at a rapid rate.
Sign up at www.emergingchinastocks.com to learn more about it.
Larry Isen
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