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June Monthly Edition: Into the Teeth of Gale Force Winds

June: Gale Force Headwinds

The gale force head winds continue to blow right into the face of China small cap stocks. This past week was "Margin Meltdown Monday". In a delayed reaction to last week's Sino-Forest (OTC:SNOFF) debacle, the network of major brokerage firms decided to change the margin requirements for China small cap, and a bunch of them absolutely tanked on Monday for no apparent reason other than margin calls.

At this point, instead of looking at Emerging China stocks, we're looking at Submerging China stocks. While problematic for the moment, I couldn't be more excited about some of the values being created in this irrational environment.

I do an informal study once every few days, and I did it Thursday morning. It's my completely unofficial and totally unscientific way of judging market sentiment on China small cap stocks.

Here's what I do- turn on CNBC at about 5:30AM out here in San Diego, and try to stay tuned if for a couple of hours.

While viewing I keep track of how many times the CNBC program hosts bash China small cap stocks. If the number exceeds 10, we know we're nearing a bear market low. I counted on Thursday morning- it was about 14 times, and later in the day they devoted an entire segment to bashing the sector.

There is a universal hatred of all things China and small- and big has not escaped the wrath of the markets of late. While I realize this painful descent into purgatory has been bloody, there are some big positives.

Valuation wise you're right in the middle of the opportunity of a lifetime. Rarely will you get the chance to own great growth companies at these ridiculous levels.

Markets always swing to irrational levels in the short term, but usually get it right over the longer term. History is replete with market crashes like the current China small cap disaster. They are always great wealth creating opportunities for cool headed investors. They are all different as to causation, and that's what one must evaluate to properly and prudently take advantage of the climate of fear.

I would argue this China small cap crash is an easy mark. In the last US crash, in order to "buy at the bottom" one had to bet the economy would come out of what looked like it could be a repeat of the 1929 depression. That was really scary. In early 2009, had you known all the big banks would be fine, you could be retired now.

In this China debacle one needn't worry about the macro environment. China, while not without its ups and downs, is certainly growing and prosperous. It's an economy that will lend itself to growth in both the consumer sector and commodities for another 10 years.

The challenge is simply a matter of accurate financial reporting and transparency. There has been a very high incidence of fraud, but I believe the majority of China based companies are delivering accurate numbers. Cultural differences lead to some of these CEOs playing fast and loose with GAAP accounting standards and practices, but those who are committed to being public companies can make the required changes rather easily.

So- here's my message in today's introduction. Over the next month or two I'm going to identify a few companies that have been vilified by bloggers making claims they couldn't possibly be certain about.

I'm going to find some very undervalued situations, and hire investigators on the ground in China to dig in at the local level. If and when I find situations I believe are delivering accurately, I'll add them to the list- right now there's only one "Strong Buy" recommendation.

If you're disappointed I'm not delivering a host of profitable ideas for you to trade today, please contact my customer service guys and cancel your subscription. I don't believe I'm going to find them that fast, and I want you to have realistic expectations. The investigative work needs to be done right- not right now. Hang in there for a while and stay in the loop. The upside is breathtaking.

At least once a week I get an email from a reader who is departing the China small cap space. The feedback: "I've lost money and all I hear are negatives everywhere on the sector."

I understand. It's been rough. It's what I would expect. It's also a sign the bottom is at hand. There will be a quick 30% easy money made in many of these companies when they come back to life. All the institutions have fled, so us stalwart individuals who hang in there will have the most equal playing field possible.

At present, I only have one real position in a China based stock, and I'm about 90% in cash.

To learn about the one stock in own in the China small cap sector, simply set up your trial subscription at www.emergingchinastocks.com.

Some Large Cap China Internets

I'm getting close to suggesting some large cap ideas as well. The large cap China based internet stocks were red hot in 2010 and 2011, and they've all gotten clobbered of late. Here's a few worth looking at- all down from early May highs:

  • Baidu (NASDAQ:BIDU)- China's Google- down 22.5% in last month
  • Sohu (NASDAQ:SOHU): China's YouTube- down 36% in last month
  • Youku (NYSE:YOKU): China's other YouTube- down 54% in last month
  • Ctrip (NASDAQ:CTRP): China's biggest online travel site- down 16% in last month

Have a look at these four. These are all large cap, high flying China internet companies that have gotten clobbered in the last 30 days and should be much higher by the end of 2011. I just can't say for sure we're at the absolute bottom. BIDU is one you definitely want to own in your more volatile large cap portfolio.

Over the next month I'll be working on to position us for a more rational China small cap market. Depend on it.
 

Warmest Regards,

Larry Isen