The Great Fall Of China: A Wake-Up Call
Three years ago, I said not to be scared of China and that its blue chips were safe. I’ve now changed my mind. Increasingly I’ve come to see Chinese stocks as policy-driven at best, and completely speculative at worst. For those who still desire China exposure, I suggest four stocks with high-quality management and less exposure to the China madness. Three years ago I was living in Hong Kong and I wrote that more investors should consider Chinese “blue chips.” I believed in the China reform story. In some ways, I still do – but in the very long term. I wrote that, after some low-level scandals in the market, the bigger stocks — those dual- or triple-listed in China, Hong Kong and the US — were safe, thanks to the extensive requirements for financial reporting. But I have come to realize that Chinese stocks are driven by the speculative greed and fear of the Chinese retail punter, and the vast majority of those punters have no concept of fundamental analysis. In a country with a singularity of government, government policy (and worse, just rumors around government policy) drive price action in stocks. Insider trading is rampant. Even stocks in listed Hong Kong can be suspicious. Muddy Waters Research’s short on Superb Summit , and the Financial Times calling out Hanergy , which was later suspended from trading, are just two examples. The environment in Chinese markets these days reminds me of the US markets of the era of Robber Barons, where those big players in the know profited from the unsophisticated average investor. (For a great read on the era of the Robber Barons, pick up Fifty Years on Wall Street by Henry Clews, originally published in 1908, which explains how the Robber Barons like Jay Gould, Daniel Drew and Commodore Vanderbilt made their fortunes.) Now the Chinese government is going after some of these so-called manipulators, many of whom have come from large Chinese brokerage houses. What kind of a market is where apparently institutional investors are banned from selling shares? It is one of total madness. Also, with State-Owned Enterprises like many of those listed in my original article, unfortunately I’ve seen very slow progress. They are still run as tools for policy, not for shareholder returns. The recent actions by the Chinese government to try to prop up the stock market demonstrate that clearly. And with hundreds of stocks suspended, daily index closing prices in Shanghai are not a true indication of where the markets should really price. While diversification is important, Warren Buffett has always said to “stick to your knitting.” Investors wanting China exposure also need to have very long-term holding horizons — to let the very slow reforms taking place in China move into place. It means that even those Chinese stocks listed in the US are likely to prove very risky, given the level of diversification they may provide to your overall portfolio. Even with the best intentions, the average Chinese management team is largely at the mercy of Chinese policy. Even the ADRs of dual-listed stocks — thanks to the larger trading volumes in the China-listed shares – are driven by and suffering from the short-term, highly speculative (and, frankly, messed-up) nature of Chinese capital markets. So what’s the solution? Obviously, one can avoid China altogether and lose out on exposure to “The China Century,” as Jim Rogers puts it. The least demanding option is to buy China ETFs such as FXI (NYSEARCA: FXI ) or MCHI (NYSEARCA: MCHI ). A third option is to be extremely selective on individual stocks. Do your homework on management teams and avoid stocks listed in Mainland China in order to reduce the volatility related to the speculative behavior of Mainland investors. One stock I like in this regard is Baidu (NASDAQ: BIDU ). Morgan Stanley has a price target of $248 on the stock, and according to Jefferies , Baidu is over 50% cheaper than Google. But for me, more importantly, it’s about CEO Robin Li. He was educated and started his career in the US and he is highly visible in Western media. His personality has won my confidence. (See interviews with him here and here .) Obviously Baidu is a “new China” play, and some may argue that it’s already fairly priced, or that they prefer Google in terms of investing in search. Three other stocks I like are China-centric conglomerates with Western or Western-style management with extremely long track records of sensible management of their assets. They are Hong Kong-listed CK Hutchison Holdings ( OTCPK:CKHUY ) (the result of the restructuring of Hutchison Whampoa and Cheung Kong Holdings), run by Asia’s richest man, Sir Ka-Shing Li; Hong Kong-listed Swire Pacific ( OTCPK:SWRAY ), controlled by the British Swire family; and Singapore-listed Jardin Matheson ( OTCPK:JMHLY ), controlled by the British Keswick family. These three conglomerates give you exposure to both industrial and consumer operations globally, but with a bias towards China trade. Although they are in very much “old economy” areas, such as property, infrastructure, energy, automobiles, transportation and telecommunications, they are run by highly respected management teams and have very long histories of revenue growth and dividend payments. The recent falls in their stock prices provide good entry points for long-term holders. While these are not get-rich-quick stocks, they will offer reasonable, equity-like returns with the safety coming from sound operations and solid management teams. As mature cash cows, they benefit from China’s long-term evolution, but involve less risk than other, “more Chinese” stocks. I have lived in Hong Kong for 5 years, been to the mainland many times and followed the Chinese stock market for the last 12 years. Right now these are the only four “China stocks” on my radar, thanks to my unease with the development of Chinese capital markets. I would recommend buying CK Hutchison and Swire Pacific on the Hong Kong exchange, tickers 0001 and 0019 respectively, and Jardine Matheson on the Singapore exchange, ticker J36. That’s because the local exchanges offer far more liquidity, and hence cheaper trading costs, than OTC / pink sheets in the US. In a side note, for those interested in shareholder friendly reform in Asia, Japan is making a lot of progress in that area with recently implemented corporate governance and share owner governance rules starting to bear fruit. From a macro perspective, it would be no surprise to you to know I prefer Japanese stocks over Chinese stocks given a 20- or 3-year time frame. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BIDU over the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.