Chinese stocks and the bubble theory
A group of Canadians experts who were early investors in China aren’t convinced its bubble will burst, and they update five Chinese stocks.
Surely we’ve had our fill of bubbles.
The bursting of America’s real estate bubble caused enough trouble. But people are lining up to predict another one. They just can’t agree on the identity of the bubble.
Some say it’s gold. Some say it’s sovereign debt (which is the going buzzword for national debt, like that of Greece).
Some say it’s China. Just a week ago, we heard from a group of U.S. experts who think so. (See Daily Buy-Sell Adviser, February 22.)
Today we turn to a group of Canadian experts who ventured into Chinese stocks earlier than many others. The independent researchers at KeyStone’s Small Cap Stock Report aren’t about to abandon the Middle Kingdom and its surging economy.
They do not ignore the challenges facing China — especially in real estate — but they still see strong growth in its future.
They also update their recommendations on five Chinese small cap stocks they have been following.
Bubble free zones
As soon as China’s central bank insisted that the nation’s banks increase reserves and draw back on loans, many pundits spoke up.
China’s overheated economy is forming a bubble, they claimed. Hold on a second, says this advisory.
“For us, it’s not as simple to paint the ‘Chinese market’ with one brush and call it one great bubble. As in North America, where markets are interdependent to a degree, bubbles can form in certain segments, while others remain bubble free zones, or reasonably priced.”
Real estate is looking “bubblicious,” the advisory admits. In December, real estate prices in 70 Chinese cities rose 7.8 per cent, the fastest pace in a year and a half. Hong Kong’s price rise was the highest in the world.
It would be foolish not to be concerned with these figures. “When you invest in China, history has told us to expect this type of volatility and that the market is not for the faint of heart.” You must go into China with a long-term approach, these experts stress.
They turn to Mr. Michael Pettis, an economics professor at Peking University. China’s economy is not nearly as dependent on real estate as America’s was, the professor insists. “The wealth effect of collapses in the real estate and stock markets isn’t likely to be big enough to affect consumption.” In fact, incomes have been rising faster than house prices.
What’s more, says the advisory, China’s property boom has been financed largely by saving, not bank lending. Still, the government is taking firm measures to discourage speculation in the real estate market.
Clothing and toys in Vietnam
Then there is the decline in Chinese exports. This leads to one of two conclusions. One, the economy is in for a huge fall. U.S. consumers are maxed out and can’t buy all those Chinese goods on American shelves.
Or two, this is actually an opportunity. Mr. David Rosenberg, the noted Canadian analyst at Gluskin Sheff, points out that consumption in China is only 33 per cent of GDP. There’s plenty of room to grow.
In fact, says the advisory, China has carefully been promoting a shift away from low-margin manufacturing toward value-added products — electronics, cars and so forth. Vietnam is willing to take on the labour-intensive, low-margin work like clothing and toys.
What’s more, despite the edict against lending, China’s banks lent more in January than they had in the previous three months combined.
There is no doubt China’s government is walking a delicate tightrope, the advisory states. But it’s not a lost cause.
“For us, concerns about slowing growth in China appear misplaced at this point as even with these steps and more moves expected later this year to slow the Chinese economy and keep prices in check, GDP is forecasted to grow between 10 to 12 per cent this year.”
At the same time, the advisory recognizes that China must keep growth from exploding to 15 or 16 per cent, which would be “far too high.”
Five Chinese stocks
With a generally optimistic outlook, the advisory looks at five stocks in its small cap “universe.” All trade in North America. None pays a dividend.
Asia-Chem Bio Group (TSX/V-ABC) makes and sells cornstarch products, for which there is an enormous market in the food, chemical and pharmaceutical industries. A big new plant begins production this year.
In less than a year, the stock rose from less than $0.50 to $1.66 today. Buy on pullbacks to $1.25 to $1.45, says the advisory, which has it as a near-term and long-term buy.
Migao Corporation (TSX-MGO) is in the potash fertilizer business, which is a lucrative one in China, although its revenues for the last quarter were down due to lower prices for some products.
Nonetheless, Migao is gearing up for expansion across the borders into southeastern Asia. Right now, it’s a hold. But it’s a strong company and relatively cheap at $7.20, which makes it a “good way for long-term investors (one year and beyond) to gain exposure to the Chinese market.”
It’s a different story for pharmaceutical firm China Sky Medical One Inc. (NASDQ-CSKI) which had a good run from less than $10 to over $25, but has some red flags with one its products. This advisory took profits and moved on. The price is $15.55 today.
Sino-Forest Corp. (TSX-TRE) owner of vast tree plantations across China, is one of the best-known of Chinese stocks. Despite weak prices in most commodities, its last quarterly report was strong.
The stock rose 100 per cent in a year (it’s at $20.97) so it’s a hold now. But it is “an excellent way to play the long-term infrastructure boom in the Chinese market,” which makes it a buy for the long term.
We conclude with a buy. Boyuan Construction Group Inc. (TSX/V-BOY) is the first “pure-play construction company based in China to be listed in Canada.” The success of this stock is tied to the growth of the economy and the urbanization of the country.
It’s cheaply valued at $3.19 but a bit thinly traded. Put in limit orders between $3.00 and $3.45 and do not chase share price, says the advisory.
Although they are cautious, these experts remain “long-term bulls” on China. In one sense, we should all hope they’re right. “For the first time in history,” they say, “China’s economy is acting as a major engine pulling the rest of the world out of recession.”
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