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The tide turns for China and emerging markets

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How China fixed the markets

How China fixed the markets

How China fixed the markets. Last week Chinese markets fell through the floor again. The triggers included some weaker growth figures (again) and more concerns over the global economy, namely the ability of the world to buy what it makes.

It appears to have stabilised now, but why?

Back in August the authorities prevented large holders of stocks trading — primarily selling– so that the markets would not see a large dip for the lemmings to dive off behind. That control was due to lapse on Thursday, but was deferred for 3 more months.

Yet the measure they have put in place makes that look sensible. Now large traders can buy, but are not allowed to sell without giving 15 days notice.

They have also removed the circuit breaker mechanisms that were intended to stop sell-offs like we witnessed this week, that actually seemed to make matters worse.

And the People’s Bank of China (PBOC) also moved to set the exchange rate higher. A midpoint was fixed at  6.5636 per dollar.

This means that the SSE is likely to rise, but not that all is now green in the garden. It is likely that many will never know about such practise, and therefore just get back on the band wagon.

I had mentioned in my January comment on a tip for 2016 that the iShares China 25 ETF (FXI) was on my radar. Here it is, the best one way bet since Soros nailed the Bank of England.

How China fixed the markets
The iShares FXI ETF. An opportunity to make hay.

I am looking to buy below 34 and sell either if and when it reaches 38, or  for whatever gain there is in two weeks.

That is how China fixed the markets, with the best intent, to protect its investors, and to give us a little profit and a chuckle on the way.




Why markets are falling

Why markets are falling

If you’re wondering why markets are falling, you are not on your own. Reasons are many and complex, but there is little to do as an investor when markets are falling except seize the opportunity. It’s not often that an article here features classic poetry. Yet the first few lines of Rudyard Kipling’s If sums up the qualities required for investing in the instant age we are now in.

If you can keep your head when all about you

    Are losing theirs and blaming it on you,

If you can trust yourself when all men doubt you,

    But make allowance for their doubting too;

Stockmarkets now move faster, with wild swings either way within hours. But this is no longer just the domain of the penny shares, or the lightly traded smallcap, or a fledgling emerging market; this is blue chip stocks, the biggest and most robust companies in the world.

So why has the movement become so exaggerated? Psychology. Now that everyone can react to news – that may have only the merest modicum of reality – in a moment, investors that have something to lose remain glued to the news feeds on their cell phones, ready to respond to whatever horror story appears.

There are of course legitimate fears arising from the increasing frequency of crisis or political mayhem that may well impact an industry sector, but there is also the complete garbage that is produced and circulated with the inferred authority of “it’s on the internet”. And here is where your problems as an investor really begin – some of it is believed.

I have followed the developing solar industry for a few years, watching companies that scaled themselves to service either domestic or utility markets, or just to create and supply technologically advanced photo-voltaic panels to the industry. Key to the cost benefit they offer is that the sun is a renewable energy source.

Yet in an absurd example of how a technology, an entire industry can come under fire, it was recently reported that a town in North Carolina decided not to proceed with a solar energy installation over fears that it would “drain the sun”. What’s more, they cancelled projects already under way and may close two already completed. It may be easy to swipe at the closed thinking of a small town community, but more fault lies with the poor journalism that was allowed to perpetuate the myths that concerned this town; that solar power may cause cancer, that there would not be enough sun for photosynthesis in the area, and that solar farm installations actually drain the energy from the sun rather than just receive it.

Some may have real fears. But the last point is a reflection of a story raised as a hoax back in 2012, and aggressively dismissed throughout 2014, yet the seed took root in the minds of the fearful. The really scary part is that the story was circulated over “social” media channels to millions waiting for the next apocalypse, and ready to “sell, sell, sell” at the touch of a button. How many people take stories like this at face value and believe and perpetuate them we don’t know, but you can be sure that it’s only a small percentage that will take time to find out the reality behind it and if necessary debunk it.

This is just one example of how the internet and the instant communication of social media channels can work against, or for you. The hope is that reason and logic return.

China markets are falling

China has a huge part to play in why markets are falling again. They have put in place a measure that calls for markets to close if a certain percentage movement occurs. If the markets falls 5 per cent they close for 15 minutes: if it goes beyond 7 per cent trading is suspended, presumably to allow some sanity to come from the information available. Such suspension suggests more worries and, spirals into other markets.

But it goes back in part to the collapse in August last year, when trading restrictions were placed on large shareholders. Those have now been removed, but even measured or surreptitious sales may have been noted and fuelled panic. The situation in China is much more complex than it appears, but underneath all the factors for global industrial and economic dominance are present.

And the contribution of oil prices to why markets are falling is scaring many. Technology has allowed for much more oil to be produced from what 30 years ago were considered dry wells. The world has more, and can produce more oil than it needs. Add this 2 to China’s 2 and many get 22. While lower oil may mean cheaper petrol eventually, and no chance of an independent Scotland, the industry is suffering. And because oil companies were, until Apple, some of the largest in the world, and the effect they have on markets falling is huge.

Investors are left with three choices. Either don’t get in the water, or if you are in, stay in regardless. Or you can use the insanity in your favour.

Option one won’t do for me at all, and option two I can live with. Option 3 means that I use what we know to our advantage. The most simple chart tells us where the price has been, and at what levels the price doesn’t tend to go below or beyond, what we call support and resistance. And we can use that information to set limit orders to buy during the insanity-driven volatility dips. You may find that orders go unfilled for a while, but the way markets are at the moment there is a good chance of picking up a bargain.

This and other strategies are described at Successful Personal Investing, TheSPICourse.co.uk.







How cheap is China

How cheap is China? – an update

If China really had had a gigantic bull market, then the tumble of recent months would not have any sensible investor getting ready to buy. But as my chart shows, this simply hasn’t happened. It is only the domestic indices of speculative stocks that soared – in the case of the Shanghai Composite, by 120% from last October to June 2015. So, how cheap is China?

Download this article how cheap is China? as a pdf

 But look at the poor old Hang Seng index of blue chip HK and China shares – it managed just a 40% gain over the same period and after the crash it is now trading at last October’s level.

Given the bungled way the authorities tried to put a floor under the market, it’s not surprising that most now mistrust all official pronouncements. But last week the government confirmed it wanted to sell off more stakes in State Owned Enterprises. That simply will not be possible until and unless domestic sentiment improves.

Meanwhile the FT reports that the powerhouse factories in South China are struggling to recruit enough workers to keep their production lines for Apple, Benetton and others humming. And retail sales are rising at around 10% and so are wages.

So I think investors should either start investing or add to their China holdings in coming months. Fidelity China Special Situations investment trust, with 30% gearing and at a 15% discount, is my own choice.

But real contrarians ahould be looking at Latin America. Here is an investment that has fallen by 20% over three months, 25-30% over six months and by 35-50% over the past 12 months. This is the one to buy if you want to prove your contrarian credentials.

I have indeed started buying, on a monthly drip-purchase. I have chosen Invesco Perpetual Latin America, an OEIC managed by Dean Newman, IP’s head of emerging market equities who has been managing this fund since 1994. He has seen this movie before. Rollercoasters can go up as well as down.

Performance of the China stockmarket indices

how cheap is china
Key :•A Shanghai SE composite•B CSI 300 growth•C MSCI China •D Hang Seng •E MSCI emerging markets


Download this article how cheap is China? as a pdf

Chris Gilchrist, October 2015

Time to top up China and EM equity holdings

Time to top up China and EM equity holdings

My recommendation in last month’s editorial column to “buy through the pain” could hardly have been better timed. Chinese stocks proceeded to provide all the pain anyone might have wanted with a vertiginous sell-off, as shown in the chart. The Shanghai market registered a decline of 8.5% on August 24th, its biggest one-day decline since 2007. Chinese stocks are now some 50% below their June peak. Thousands of stocks have hit the limit of one-day declines of 10% and had trading suspended. Excitable news commentaries soon blew this up into a general panic that hit all world stockmarkets.

In fact, the China story is not the key to where economies and markets go next. The major developed markets either have growth momentum (the US and UK), or QE that looks as if it is starting to generate momentum (Europe and Japan). These economies (Germany is the possible exception) are not highly dependent on trade with China and the major growth that is happening is in services rather than manufactured goods. So while China and emerging economy slowdowns will reduce world GDP growth, perhaps to 3.3% in 2015, growth in developed markets overall is more likely to accelerate than decline. The low rate of core inflation in developed markets (averaging 1%) gives central banks an excuse to delay interest rate rises still further. Oil at under $50 per barrel and lower commodity prices mean headline inflation rates will probably trend down until well into Q1 2016.

The global macroeconomic background is therefore quite positive and neither macroeconomic nor monetary indicators signal an end of the bull trend. Some analysts say everyone still has far too much debt and this will act as a progressively worse drag. But much of this debt is accounting fiction. For example, how much of the government debt held by central banks can be said to still actually exist? And if an interest rate rise of about 1%, and hence the discount rate used to value liabilities, would eliminate all the pension deficits of the FTSE 100 companies, how real are those supposedly vast pension deficits?

The challenge for China

The transition from an investment-led to a consumer-led economy was always going to be a huge challenge for China. It has achieved as much of a consumer boom as anyone could expect – wages continue to rise at 10-15% and so does consumer spending. The only problem is that investment has declined even faster – as it had to – and the process of making massive state-owned businesses more efficient is a work of years rather than months. I suspect that if the Chinese authorities had got a large placing of shares in one of the SOEs away in Spring 2015, they would have slowed the market enough to prevent the summer sell-off. As it is, with only 6% of Chinese actually owning shares, and virtually no institutional investors in the market, the market in local shares is like nothing anyone alive today has ever seen, though if you could channel the ghosts of late 19th century US investors you might get close. To be fair, the authorities are rushing to introduce regulation to the wild east of China’s markets, and are probably ahead of where the US was at this stage of its history, for example in restricting trading on margin, where the US only introduced serious restraints after the 1929 crash.  But as history proves, nothing can restrain the madness of crowds.

Performance of Chinese stocks and Fidelity China Special Situations

Performance of Chinese stocks and Fidelity China Special Situations
Key :•A Shanghai Composite INdex•B Fidelity China Special Situations Fund•C MCSI China Index

The divergence in performance and rating within China is vastly greater than most people assume. For example, according to fund managers Hermes, recently the average prospective PER on the Hang Seng China Enterprises Index, consisting of large HK listed companies, was 8, as compared with a figure of 70 for the ChiNext index of high-tech start-ups. The Shanghai Composite, with 1,100 companies, had an average PER of 15 while the larger Shenzen market (1,700 companies) had a ratio of 30.  Fund managers tell me they continue to find good businesses to buy on very undemanding ratings.

Tactical errors

The Chinese authorities’ reactions to the panic have been inconsistent. They banned large investors from selling stakes and effectively stopped short selling, then deployed a sum of between $150bn and $200bn to “market stabilisation” purchases, which has predictably been ineffective. On the other hand, they are improving brokerage and market regulation. They have cut interest rates and also bank reserve requirements, providing a monetary boost, and analysts expect a supplementary fiscal boost shortly. Most analysts expect the Chinese to avoid a meltdown or a “hard landing”: GDP growth this year may end up nearer 5% than 7%, but if it is inefficient and unproductive investment that is being subtracted from GDP, the effect will probably be smaller than most people think.

JPMorgan’s data confirms the valuation opportunity: their composite figures as at end-June showed China trading on a prospective PER of 10.6 as compared with a 10-year average of 11.8, and a price to book ratio of 1.2 versus a 10-year average of 2.1. Those figures will be at least 20% lower now. Its data also shows emerging markets as a whole at well below their historic average valuations.

Meanwhile, most fund managers have cut emerging market equity holdings and are underweight or heavily underweight the entire asset class. So it is at least arguable that we are being offered a once-in-a-decade opportunity to buy into an asset class at bargain levels.

If you go along with this, then you need to decide whether to buy a global emerging markets fund and leave the managers to decide how much to allocate to China, or pick a dedicated China fund and endure greater volatility. Or, as I have done, do both. I have selected three emerging market funds, all with highly regarded managers and better than average performance records. Somerset’s Edward Lam is very long-termist and with EM dividend-generating stocks at a discount to their long-term averages you could view this fund as offering a double discount. Its lower Asian allocation means it will likely be less volatile than the others. Fidelity and Hermes are both active asset allocators. Both managers are positive on China and Asia – we have yet to see any manager allowing themselves to express a bullish view on Brazil or Russia, both of which now have pariah status in the investment community – and both say there are plenty of good businesses whose shares they can buy at sensible prices. My own recent choice of these funds has been Hermes.

Emerging market funds’ performance

Emerging market funds' performance
Key ::•A PFS Somerset EM Dividend Growth•B Fidelity EM Retail•C Hermes Global Emerging Markets

For a pure China exposure, I am sticking with Fidelity China Special Situations investment trust. Its level of gearing at 29% has pulled it down but will also propel it up when the market turns. Add that to a current discount to NAV of 15% and there is scope for sizeable and rapid gains. I have recently added to my holding and may well do so again.

Chris Gilchrist, September 2015

China The dragon roars into life

China – The dragon roars into life

In September 2014 (Issue 359), I advised readers to ignore the GDP numbers for China and trust the consumer boom then taking off. Since then, the GDP numbers have got steadily weaker, leading to plenty of bearish comment on the stock market. But, as I said at the time, if consumer spending and wages are both rising at 10-15% annually while inflation is under 5%, why wouldn’t you invest? A return of over 40% since then is good enough, but my feeling is there could be a lot more to come.

Since last Autumn, the Chinese themselves have started to pile into the market in a major way. Obviously, the main reason is that they can’t make easy money in property any more. Property prices continue to slide gently, but with no sign of a crash. So new brokerage accounts have been opened at record rates and prices of small domestic stocks have soared. Whether such stocks are sensibly priced on PERs of 30 to 50 is debatable, but a well-run business ought to be able to raise profits at a much faster rate than 15% if that is the average growth in consumer spending. This isn’t a scenario that lends itself to analysis using the “secular stagnation” models of Western analysts.

Central bank maintains control

The central bank seems to have learnt its lesson from last time around, when a vast wave of liquidity and investment spending created all sorts of problems including much bad lending. Having tightened monetary policy by raising rates, it is now easing policy not with rate cuts but by reducing the size of the deposits commercial banks have to keep at the central bank. At the same time, central government is starting on plans to consolidate and tidy up local authority debts, while state owned enterprises (SOEs) are under pressure to become efficient and earn a return on their capital. All this is positive for the long term, so the drop in investment that is causing the decline in the GDP growth rate is, to my mind, almost irrelevant.

Go wild, go East

Naturally, a market like China is likely to have Wild East qualities for a long time to come. It’s probably best to think of it as like Wall Street in the 1920s. Individual investors will probably trade with greater and greater leverage as the market climbs. There is a serious risk of sudden shocks and market plunges. But these are, I think, likely to be short-term so long as that consumer boom continues. The reason is simple: if a stock is overpriced on a PER of 50, it takes only two years of earnings growth at 15% to reduce the PER to 22.

There is no doubt the domestic market is getting speculative. The Shanghai index is up 107% in 6 months and 144% over a year, as against 46% and 61% respectively for the MSCI China index and 31% and 44% respectively for the Hang Seng index. But the Chinese are the greatest gamblers in the world and have only just started to party. The local index, which carries less weight of boring behemoth SOEs than the MSCI index, could easily double again over the next couple of years.

Fidelity Special Situations Investment Trust, my major holding, is up 43% from last October and 69% since last May. Jupiter China, the best of its OEIC rivals, is some way behind as the chart shows. Fidelity has benefited from its gearing and so long as the bull market continues will go on doing so. Taking into account gearing of 26% and a current discount to NAV of 13%, it looks the obvious fund to buy as compared with ungeared OEICs.

Key :•A Fidelity China Special Situations •B JP Morgan Chinese IT •C UT China/Greater China •D Jupiter China Acc

Chris Gilchrist, May 2015

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