Friday, July 24, 2009

Bookkeeping: Selling China Exposure as Chinese Run In - Morgan Stanely China A Shares (CAF)

While the Chinese had admitted that a lot of their stimulus has found its way into the domestic stock market, and being a contrarian does not work very much anymore, I am starting to become less optimistic about the near term prospects for continued price appreciation. Last year around this time I posted a story about how Brazilians were celebrating how immune their stock market was, just before it imploded. In the late 90s you heard stories of taxi drivers giving hot tech stock tips. Than 2000 happened. And in late 2007 we saw a very similar thing in China as I am now reading again - the flocking to markets with newbie money. That doesn't mean it ends in 4 weeks, or even 4 months. It is just something to have your radar on; I was turning negative on China in September 2007 and it took a good 2 months to really taper off and ,the largest IPO ever: PetroChina (PTR) was the signal [Nov 5, 2007: PetroChina the 1 Trillion Dollar Company? Is *THIS* the Top?]

Well in the weekly attempt to call the top in the Chinese market, I wonder if the Chinese valuing Petrochina at double Exxon as the world's first 1 trillion dollar company *is* a near term top? ;)
  • PetroChina became the world's first company worth more than $1 trillion on Monday, surging past Exxon Mobil as the Chinese oil producer's shares nearly tripled in their first day of trading in China.
  • Adding the value of PetroChina shares traded in Shanghai, Hong Kong and New York - and those still owned by the government - the company's total market capitalization ballooned to just over $1 trillion, compared to Exxon Mobil's (XOM) $488 billion.

Ah, nothing like a bubble is there? So even as I was warning of the madness for a good 6 weeks straight (like that crazy guy on the park bench in his trenchcoat) - some of the largest gains in October 2007 (when US markets peaked) were small cap Chinese stocks listed in the US - many were going up 30-50% in a single day. But like all good bubbles, this one ended in spectaculator fashion. Not 5 days after that PetroChina piece I penned [Nov 10, 2007: Chinese Big Caps Struggling Since PetroChina Shanghai Debut]

Sometimes, in retrospect, we can look back at a moment in time that seems either outrageous or telling, and see a warning signal is flashing in the middle of a mania. I have pointed this out in previous entries ranging from
  1. The Macau gambling stocks (Steve Wynn cashout), on the heels of private equity 'cash out' via Blackstone IPO (BX), on the heels of Sam Zell cashing out at the top in commercial real estate during the private equity feeding frenzy [A Top in Casino Names?]
  2. The Chinese small cap bubble frenzy earlier in October [This Day in Bubbles Series]
  3. The dry bulk shipping frenzy [A Chorus for Dry Bulk Shippers - Enough Already?] and [A Near Term Drop in Dry Bulk Shippers?]
  4. And our most recent frenzy, that of the solar companies [Closing LDK Solar on the Mania that is Solar] and [Suntech Power Up 8%.... on a Downgrade]
What is consistent is the speculative frenzy and I have been amazed to watch it move from 1 sector to another.

And the rest was... as they say.... history.


So now we have had in the past week nearly half a million new Chinese brokerage accounts opened... and the largest global IPO since Visa (V) almost 18 months ago. Might be some parallels here.... although perhaps not the full fledged excess we saw back *then*. Remember all bubbles end with a parabolic move... the dry bulk shippers, the Las Vegas casinos, the Chinese stocks, the solar stocks - you had repeated days (and weeks) of 20,30,40% moves that left you awe struck. We have nothing like that yet - just some percolation; and a cool 12 day NASDAQ winning streak (still a chance for 13!)

Via Bloomberg:
  • Chinese investors are rushing to buy into the world’s second best-performing stock market following the end of a ban on initial public offerings and a rebound in economic growth.
  • Individual investors opened 484,799 stock accounts last week, data from the nation’s clearing house showed today, the most since the five days ended Jan. 25, 2008. “The prospect of making quick bucks in the stock market is luring retail investors,”
  • The Shanghai Composite has risen 81 percent this year, trailing only Peru’s benchmark.

China State Construction Earnings just IPO'd for nearly $8 Billion
  • China State Construction Engineering Corp., the nation’s largest housing contractor, raised 50.16 billion yuan ($7.3 billion) in Shanghai in the world’s biggest initial public offering in 16 months. The IPO, the fifth since China ended a nine-month moratorium on sales in June, is the biggest worldwide since Visa Inc. collected more than $19 billion in March 2008.
  • The IPO values State Construction at 51.3 times earnings.
  • State Construction’s sale is the biggest in China since PetroChina Co. raised 66.8 billion yuan in October 2007.
Shanghai overall is now at 36x earnings; but our REALLY long time readers will know the Chinese market is "closed" (i.e. no shorting, no foreign money) so its a bit of a parallel universe. [Oct 13, 2007: Shanghai - the Mystical Land of Premium Valuations] The same stocks that trade in Hong Kong are traded many times for 50-100%+ higher valuations in Shanghai. (well back in late 2007 it was more like 150% higher - its since "cooled down" hah)

You remember Shanghai correct? The magical land where valuations of stocks are 150-225% higher than they are in either Hong Kong or the US for stocks that trade on all 3 exchanges. See this story for a graphical representation,

That's just the arbitrage between the 2 markets, one open; one closed.
  • Still, the rally has made Chinese stocks the most expensive since January 2008, Bloomberg data shows. Shares traded on the Shanghai index are valued at 36 times earnings, almost triple a November low of 12.9 times.
  • At the peak in October 2007, the benchmark index traded at 48.7 times profit,
Much like the US in late 90s and as we're trying again, the government can create any valuation it wants if it chooses to print money and stuff it into the economy. That's a nominal valuation of course. So valuation is relative - certainly China could go to a 50 PE or the US to whatever Larry Summers wants. We were paying 80x for Cisco since Uncle Al said recessions were outlawed in the U.S.; and well over 40x on the NASDAQ as a whole. In the depths of one of the worst recessions in modern history we already appear glad to be paying 20x forward estimates on the S&P when many companies are shrinking ... at least the late 90s were a time of growth. But since the US dollar is just a toy now, who cares - as long as the US peasants see their stock market go up "everything must be ok". Even as they scratch their head why grocery prices just continue to shoot up month after month.

Without digressing too much, valuation is not quite so simple as "what things should be" - fixed amounts of asset chased by ever increasing supply of paper currency can do interesting things.

Back to Chinese investors flood in, and in fact investors from all over the world do as well...
  • Funds investing in the so-called BRIC nations of Brazil, China, India and Russia added $2.1 billion for an 18th straight week of gains, EFPR said. China funds posted the largest gains, adding $243 million, while Indian funds attracted $148 million.
  • “When investors last believed in decoupling back in 2007, we saw substantial hot money inflows into China. That has started to resume.
Perhaps a little caution is in order?

We're going to lock in gains in Morgan Stanely China A Shares (CAF) here at $36.85 (taking it down to a 0.1% stake), and look to buy on a dip, if and when they ever come again ;)

Even the biggest bull on China is getting cautious.
  • I don’t like buying when things are going straight up and China has been going straight up for nine months,Jim Rogers, chairman of Rogers Holdings and the author of books including “Investment Biker” and “Adventure Capitalist,” said in a Bloomberg Television interview in Singapore today. The nation’s stock market may have “gotten ahead of itself,” he said.
Much like Jim I'm a 10-20 year bull on China. The next 10-20 days? Taking the safer route.

Again let me reiterate - these markets can keep going up for months; I am not making any sort of near term call other than pointing out a lot of interesting signs and taking my (virtual) shareholders money to higher ground. To partake, instead I'm making select bets on China via US companies with good exposure there who still are relatively cheap.

EDIT 1 PM: Thanks to reader Andrew for getting us this chart of Shanghai - woosh. It also shows me what a lousy job CAF is doing at 'representing the performance of Chinese A shares''; I should of made a lot more money on CAF if it was following Shanghai accurately. Unfortunately, CAF is a closed end fund in which the premium has dropped from 30% to 0% in the past 3 months; ugly.

[Apr 20, 2009: Bookkeeping - Beginning Morgan Stanely China A Share Fund]

Long Morgan Stanley China A Share Fund in fund; no personal position

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