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Wednesday, September 26, 2007
A friend owns a business in China recycling old computers...
"The Chinese have no concept of stocks going down," he told us this morning. "I met an engineer in Shanghai earlier this year. He's doing really well in the stock market. His stocks rise every day. It feels like easy money to him.
"I tried to tell him that stocks go down sometimes too, but he didn't believe me. So I gave him examples of some of the stock market crashes we've had here (in America). He was amazed. He'd literally never heard of crashes or bear markets before..."
Times are crazy in the Chinese stock market these days. Yesterday, shares of China Construction Bank debuted on the Shanghai stock exchange. It's the largest Chinese IPO to date. Shares popped 32%. This disappointed investors. They had expected a 50% increase. Construction Bank's Hong Kong listing plummeted 7%, reflecting this disappointment.
The Chinese stock market may have some of the highest stock valuations anywhere in the world, but the money keeps pouring in. Much of this money comes from retail investors with no experience in the markets... like the engineer. Since the beginning of 2006, the Chinese stock market has risen 400%...
China Shares Rise 5X Since The Start of '06
Yesterday, I spoke with another American businessman doing work in China...
"China is an accident waiting to happen," he said. "I have some very good friends, executives at the top of multibillion-dollar major exchange-traded Chinese companies, who say the whole thing is a house of cards. The numbers being reported by most of the companies are in many cases fraudulent and all of the banks are essentially bankrupt.
"The financial chaos coming will make the U.S. savings and loan crisis look like a picnic. The Chinese idea of a loan is free money. They get a loan, put down 5% to buy land, and then borrow 100% against the land (ostensibly to build a factory) with no intention of ever paying it back. They may be able to keep this going through the Olympics next summer, but after that, look out below..."
Personally, I wouldn't invest a penny in China. I don't trust the communist party's ability to control such a juggernaut economy. I read last week that one-third of all prices in China are set by authorities. Humans are terrible economic planners. Many mistakes must lie underneath the shiny surface. And Chinese investors have no experience with booms, busts, and panics. That makes booms and busts more likely. And when they happen, they'll be more severe... like they were in the U.S. 150 years ago. That's why I'd never short China either. No one knows how long this madness can continue.
So what's the right way to play the Chinese growth story? Taiwan.
Taiwanese companies have all the same fantastic economic fundamentals as Chinese companies but without the nosebleed valuations. Our resident quant, Ian Davis, points out that, of all the indexes in the Thomson Datastream database, Taiwan is historically the cheapest country as measured by its median price to earnings, price to book, and dividend yield. Right now, Taiwan is the only country in Datastream trading at a discount to its historic valuations.
In other words, Taiwan is even cheaper now than it normally is.
It's still illegal for Chinese investors to invest outside China. But that's changing. On August 20, authorities announced a plan for mainland Chinese to invest in Hong Kong. The news has sent Hong Kong's Hang Seng Index up 30% in the last month.
Peter Churchouse, a legendary Asia investor who suggested this trade to us earlier this year, thinks Taiwan could be one of the next markets Chinese authorities open up to mainland investors. If this happens, we should see a similar pop in Taiwan's stock index...
The Taiwan ETF (EWT) is the easiest way to invest in Taiwan. There are also two Taiwan closed-end funds: the Taiwan Fund (TWN) trades at an 11% discount to NAV, and the Taiwan Greater China Fund (TFC) trades at a 13% discount to NAV.
THE CHINESE INVESTORS REV UP THE HONG KONG MARKET
As noted above, on August 20, 2007, Chinese authorities opened up Hong Kong markets for mainland investors.
So far, it's only a pilot program. Only the Bank of China will be able to open accounts for mainland residents to trade Hong Kong stocks... and only four branches of the Bank of China, in the northern city of Tianjin, at that. Other banks have applied for approval, but so far that's it.
According to China Daily, the announcement spurred thousands of investors to open accounts, and thousands more are making inquiries.
As the chart shows, the Hong Kong stock market is already benefiting massively from the pilot program: