Archives - Business: Page 19
Author: paul carson (Fri Mar 02, 2007 2:31 am)
Title: BUSINESS
March 1, 2007
Dear Fellow Investor,Well, it’s been quite a week in the markets, hasn’t it? And China has been right at the heart of what’s going on. You may have heard me say before that every investor needs a China strategy because China is the most important investment theme in the world right now, and we certainly got proof of that this week.I know it’s difficult to make sense of big market moves like we’ve seen this week, especially when one of the key events happened half a world away. So in this week’s Dispatch, I thought we’d take a few minutes to talk about what happened in the Chinese and U.S. markets and what it all means for investors like us.So What Happened?First off, let me say that I do not believe this was the start of something ominous, nor have the long-term investment trends we’re profiting from changed. In many ways, it’s part of the natural market cycle, and I expect it to be good for us in the long run. The Mainland Chinese stock market in Shanghai had its biggest one-day sell-off in 10 years Tuesday with a 9% drop. (This came on the heels of an all-time high close the previous day.) What caused the selling? I've spent the last few days following this closely and talking to our analysts in China, and I believe there were four main factors that contributed to it:1. Speculation that the chairman of the China Securities Regulator Commission (China's SEC), Shang Fulin, may leave his job soon. Mr. Shang is the chief architect behind Mainland China's capital market reforms and the key official who helped turn the Shanghai stock market from the worst-performing market in the world during 2004 and 2005 into a 130% gainer in 2006. Rumors of his imminent departure worry market participants. I believe that these rumors may be exaggerated, but even if he does leave, the market will move forward along the path he set. The reforms will continue in the Shanghai stock market. 2. Talk of aggressive interest rate hikes in China to slow down the red-hot economy. This is nothing new. I believe that China has room for more interest hikes, and I can understand why Beijing needs to prevent the yuan from going up too fast. A skyrocketing yuan would have a negative impact on the low-margin contract manufacturers in China, so the government is trying to manage the yuan’s appreciation. For this year, I expect probably two more interest rate hikes, which won't derail the long-term trends we're profiting from. 3. There was also talk about the Chinese government collecting capital gain taxes on investments, which are tax-free at the moment. I told my China Strategy readers in a special Flash Alert Tuesday that the kind of volatility we saw this week hurts China's efforts to develop its capital markets, and I expected government officials to come out soon to clarify their intentions. Sure enough, the very next day word came out that there would be no capital gains taxes on stock and mutual fund investments in Mainland China. That news came as welcome relief to both individual and institutional investors—domestic and foreign—and as a result, Shanghai’s market recouped half its losses on Wednesday.4. And finally, a lot of the selling we saw can be attributed to general profit-taking after the major run-up in China. Some large institutional shareholders of giant Chinese state-owned enterprises (SOEs) took profits after the year-long rally. The Shanghai market went up too much too fast in 2006, and was up substantially already this year as well, so profit-taking was to be expected, but the other factors we just talked about accelerated it to where it was an overblown panic reaction. From a technical standpoint, the 3,000-level in the Shanghai A Share Index is one of strong psychological resistance, and after last year's 130% run-up, the market needed to flush out some weak investors before the rally could resume. I’ve always avoided the Mainland Chinese Shanghai A Share market because of the high valuations and poor quality of the companies listed there (most of which are SOEs that are poorly run, and some are downright corrupt). In China Strategy, we’re profiting from the much higher-quality companies you can buy and sell right here on the U.S. exchanges. But the fact remains that Chinese investors have very few options to earn good returns on the $3 trillion they've saved in their banking system. This will not change anytime soon, so I expect China's markets to remain strong. (I cover this in more detail in the brand new issue of China Strategy, which will be released online tomorrow. Click here to join now and you’ll be among the first to read about it and my brand new recommendation.)In fact, here's a fascinating development you may not have heard about: On Tuesday, in the midst of all this selling in China, there were two new Mainland Chinese mutual funds launched. One of the two collected over $1.3 billion from individual investors in just a few hours. Demand was so strong the company had to suspend the subscription at lunchtime to avoid oversubscription!U.S. Markets ReactYou’re no doubt well aware how the U.S. markets responded to what happened in China. The S&P 500, Dow and NASDAQ were all down over 3%. A weak durable good report and an attempted terrorist attack on Vice President Dick Cheney in Afghanistan added fuel to the fire. But as in China, the markets rebounded somewhat on Wednesday before dipping back a little today.Tuesdays’ selling in the U.S. was overdone. A lot of it was clearly an overreaction by some investors to what happened in China, but there’s another important point to keep in mind: Much of the sharp downdraft late in the day came as a result of computerized program trades. One thing I’ve learned in my career is that large institutional investors such as hedge funds, mutual funds and investment banks dominate the market in the final 90 minutes of trading. The trading platforms used by institutions tend to be lightning fast and highly automated. This is an advantage in most circumstances, but when extremely large trades are made—as we saw Tuesday—it can overload the system and knock the usual balances between bid and ask prices out of whack. Around 3:00 p.m. EST on Tuesday, a large options-related sell program hit the market and caused the Dow to drop 250 points in only 20 minutes! This is mindless, automated selling, and it almost always works against those who get caught in the middle of it. This is one reason I advised my China Strategy readers to sit tight while things were so unsettled.Here’s an interesting point you may not realize: In the U.S., “crash” days like we saw Tuesday generally take place during bull markets, and they are actually healthy because they flush out the speculators. I believe Tuesday can be viewed in that context, much like other one-day crashes we saw in 1987, 1997 and 1998: a healthy part of the market cycle that should be good for us in the longer term.In addition, big down days have always taken place on the fourth or fifth consecutive down day, which is what happened Tuesday, and they were followed by a bounce back up.So what can we expect going forward? In my years of observing markets, we typically we’ll see a bounce and then usually another leg down as the market retests the recent lows before resuming its upward trend. I expect to see a similar pattern this time, so no matter what, you should expect increased volatility in the short-term.Long-term, however, the positive fundamental trends behind the bull markets in the U.S. and China remain firmly intact.
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