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Andy Xie: Chinese Market in Final Frenzy, Again

08/05/2009 by Research Reloaded

We're not alone in questioning the prudence of buying into the Chinese market right now. Turns out Andy Xie, previously of Morgan Stanley, has some pretty sober words for what he sees as a bubble in Chinese asset prices. (via Clusterstock, Barry Ritholtz)

The stock market is in a final frenzy again. The most ignorant retail investors are being sucked in by the rising momentum. They again dream of getting rich overnight. As in the past, retail investors usually lose, especially like the ones jumping in now. The final frenzy usually doesn’t last. The turning points in China are often related to political calendar. Retail investors hold the popular belief that the government won’t let the market drop before October 1, the 60th anniversary of the PRC. Last time it was the 17th Party Congress in October 2007. This sort of belief is self-fulfilling in the short term. The market tends to roll over around the time. If the past is of meaningful guidance, this wave will taper off before October.

The idea that the government wouldn’t let the market drop is rooted in Chinese market psychology. In financial jargon, it is called a put option. During the Greenspan era, financial markets believed that he would always bail out markets in a crisis, which was the so-called Greenspan put. The belief in China should be called the Panda put. However, in reality, the government couldn’t reverse the market trend when it turns. Chinese stock market has big ups and downs in the past, which shows the government’s inability to stop the market from falling. Nevertheless, this imaginary put option remains deeply rooted in popular psychology.

Note that Andy Xie labels current China market bulls as "the most ignorant retail investors". If we then further consider Goldman's latest bullish China strategy piece we discussed in our last post, and assume some of GS's clients end up following the piece (almost guaranteed) it means that it's not just ingorant retail investors, but professionals as well who are "being sucked in by the rising momentum". (As Mr. Xie illustrates so nicely)

Goldman: Please Keep Trading the China Bubble

08/04/2009 by Research Reloaded

 Sometimes "professional" investment research resembles little more than a day trader rag with nicer charts and fancier wording to make the reader feel less guilty and more professional about the kind of "investing" he or she is actually performing. Thus we point to Goldman's recent China "Portfolio Strategy" dated July 31st where they tell us to basically keep buying the Chinese market based on government support for the economy and a "favorable liquidity setup". We're told to buy on dips, "stay engaged" (ie. keep generating commissions), and trade earnings suprises. Is this professional investing or what your college roommate was doing during the dotcom bubble? It's hard to tell the difference.

Market view: Stay invested; buy on dips for new money A-share market gained 12.4% in July despite a 5.3% correction, which was provoked by concerns regarding credit tightening, on July 29. We maintain our positive market view on A shares and think the government’s pro-growth policy stance, which should ultimately lead to macro/earnings recovery and a favorable liquidity setup, will continue to bode well for equities.That said, we see price volatility nudging higher as uncertainties revolving around interim earnings and the government’s monetary policy stance intersect with an above-mid-cycle multiple (24x). We would stay engaged in the market and look for opportunities to accumulate positions on dips.

Strategies: Domestic demand exposure; Trade earnings surprises We recommend investors to focus on the following themes to gain exposure to the A-share market: (1) Laggards with valuation buffers and reasonable EPS growth; (2) Pro-cyclical domestic demand, which includes banks, insurance, property, and selected consumer and materials names; (3) Stocks that are potentially subject to positive earnings surprises.

That's the front page: trust the government to support the market, trust dumber investors to follow you (liquidity) and try to make little earnings trades hoping for pops. Oh wait. What about valuations?

Valuations: Above mid-cycle, but may persist CSI300 is now trading at around 23.9x I/B/E/S consensus P/E and 3.2X P/B on a 12-month forward basis against an average of 18.9x and 2.0x since April 2005, respectively (see Exhibits 1 and 2). On the basis that FY09 EPS growth for the aggregate market could be lower than the 15% that I/B/E/S consensus is currently forecasting, the forward P/E for CSI300 would be even higher at around 26.6x using our FY09 EPS growth assumption of - 5%. July 31, 2009

So valuations are sky high and earnings estimates might be missed. But we should hang on, because high valuations may persist. That's our upside investment case. High valuations may persist... and actually need to go higher or have upside earnings surprises to really give us upside on stock prices since they are already stretched as it is. Also, note that they compare recent valuation multiples to the average since... only 2005.. which was still a pretty bullish period for Chinese equities. So valuations are stretched even above what we saw during a pretty bullish time for China, but we should just have confidence in the government and liquidity to keep pushing things higher. This is what we are made to believe is "professional investing" rather than a gambler's punting.

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