To OTC Journal Members: 
 

What's Wrong With China Stocks? Nothing Earnings Can't Fix

Have you noticed the fall off of late in China stocks? Most of the small cap China stocks I've been reporting on for some time have given back a lot of ground on low volume pullbacks. None of them have reported Q1 earnings yet. Now that we're past May 1, the Q1 numbers will start coming in fairly soon.

Here's a few notables from my favorites that have thrown in the towel of late: China Education (NYSE: CEU); China Recycling (NASDAQ: CREG); Biostar Pharma (NASDAQ: BSPM); and NF Energy (OTC BB: NFEC). Outside of my favorites, I've taken note of others with strong trailing numbers who have been victimized by low volume by pretty nasty pullbacks- specifically Acorn (ATV), China Biotics (CHBT), China Real Estate Information (CRIC), Duoyuan Water (DGW), E- House (EJ), KingZhong (KONG), China Life (LFC), China Nepstar Chain Drug Store (NPD), and Vision Media (VISN). The list goes on and on.

For the most part, every company on this list is thriving. What gives? These stocks climbed the "Stairway to Heaven" for about nine months, but in the last 30 days have taken the elevator straight down. I believe there are two major factors pushing these stocks down.

First and foremost, it's the seasonal, cyclical factor. It's "Go Away in May" time. China stories ruled the markets for about 8 months- August to March was a blockbuster time to have the right China stories. Now, we're in the twilight zone of market malaise- the buyers strike if you will. The market, and the China stories seem to be exhausted, and need some time to rest and restore their energy. Profit takers are around, and buyers to match them are nowhere to be found. If you look at the charts of the stocks listed above, you will see low volume water fall declines across the board. It's not specific to one company- it's specific to a whole investment theme- small China stocks that did very well for about 8 months are just dying due to lack of interest.

This lack of interest phenomenon is very seasonal in nature, and I'm pretty sure this year the seasons will get back to some semblance of normalcy. Here's some evidence- check out this chart from Google Analytics, which I believe can be used as a tool to predict movement in stock groups once one dials into the key words people search for. This is a chart of the relative interest in the term "China Stocks" as provided by Google. Note the giant spikes in the Fall and just last month. Currently, the term "China Stocks" has its lowest search rating in the past 12 months. Interest is at the low end of the scale.

Historically, one might expect the interest in stocks to hit their lows in mid summer, and begin a rebound phase in August that should last a number of months and bring many China stocks up to valuations more commensurate with historical norms. 

The second major factor driving China stocks lower is the turmoil in Europe, sparked by the banking crisis in Greece. While the Asian economies, India, and South America have led the way out of the global recession, and the US has the silver medal, it appears Europe has more pain to absorb to get out of the credit melt down. The Europeans are also consumers of China manufactured products, and a deep European recession sparked by a credit melt down looks as if it is headed to Spain and Portugal before the patient can get healthy again.  The Euro is weakening across all global currencies, giving Euro holders less buying power and making imports more expensive. 

The sell off will have run its course over the next several weeks as we get into Q1 earnings season and investors are reminded how well these company's are functioning. Q1 tends to be the worst in China. Much like our summer vacations, the Chinese have Chinese New Year - a major business interruption. It's in January, so the commerce shut down is reflected in Q1 numbers. Despite the seasonal variances, numbers will be strong.

Many of the names you see listed in the first paragraph are grossly oversold relative to corporate performance, and upcoming earnings releases will serve to remind investors what they've got. China companies tend to report late for two reasons. First, there's the delay in information flow between China and the North American service providers- the accounting firms- US based CFOs, law firms, etc. The information takes a little extra time to get over.

Then, there's also the translation issue- not just translating Chinese to English, but also currency changes. This delays the filings a week or so, and hence China companies tend to report a little later in the cycle. I don't believe one of the China companies on the above list has reported Q1 yet, but they all will deliver over the next two weeks. 

On the more macro front, there's a lot of reasons to believe the fortunes of a lifetime are there to be made investing in China over the next 5 to 10 years. It's all about the Yuan, aka the RMB on financial statements. The potential appreciation of the Yuan has been widely publicized- the world is bitching and moaning about the Chinese currency. The Chinese have simply not allowed their currency to float against other global currencies. 

The Euro and the Dollar should be going down against the Yuan- but the Chinese have not allowed their currency to float since the summer of '05. Since then, the global markets have roiled in turmoil, the US Federal Reserve has been printing money to "buy" our way out of the recession. The Chinese have not had to print money, but have been buying ours. Their recession was very shallow and short lived. Their financial institutions are not over leveraged.

When you print dollars and Euros, you create an excess supply. When there are excess supplies, there are lower prices. The Chinese are not printing an excess supply of Yuan. Therefore, the price of the Yuan needs to go up, which is what the global community is whining about.

On April 8th Geithner visited Beijing and met with his Chinese counterpart. It is widely believed this was the meeting where the Yuan was discussed, and the world now expects the Yuan to appreciate against the dollar beginning within the next month or two.

What does this mean to China stocks with US listings? Chinese companies do business in their currency. Once the bottom line is determined, the number is translated into dollars. A weaker dollar against the Yuan equates to higher EPS for a US listed company doing business in China. Owning China based stocks is a good way to bet on the devaluation of the dollar against the Yuan.

That's just the beginning. A stronger Yuan will hurt China exports, but make imported commodities cheaper to China consumers. Domestic consumers will be able to sharply increase expenditures, and thereby create more wealth within China. 

Then, there's the reason the whole world wants the Yuan to appreciate. In the past five years the number of Chinese with meaningful spending power has doubled from 5% to 10% of the population- this represents 130 million people- or put in perspective- the entire population of Japan. The number is growing everyday.

We want to sell our stuff to the emerging consumer population- GM certainly does as their Q1 sales in China were up 77% over Q1 of '09. In order to sell our stuff to them, they need the buying power a stronger Chinese currency will create. This macro picture bodes very well for the companies doing business in China I currently write about, and the ones I plan to write about down the road.

About a year ago I was looking at Universal Travel (NYSE: UTA) and wondering how the stock could possibly be so cheap with the numbers the company was generating. At the time, it was $2 on the bulletin board. By September it hit a high of $17 and is now on the New York Stock Exchange. I rest my case.

In the next year many of the stocks listed above will go on to make new all time highs and make fortunes for those with a little faith. Stay tuned for earnings reports and an in-your-face reminder of why you'll make so much money in this sector. 

Home Page : www.otcjournal.com
Email Questions or Comments To: editor@otcjournal.com