This Little Piggy Went to Market

There's an age-old Wall Street saying: Bulls make money, bears make money, but never pigs. The problem with the pigs, of course, is enough is never enough. So by being too piggish, profits often go down the drain.

I thought of this saying the other day after chatting with Tony Sagami, one of the country's leading Asian investment experts, and then reading a research piece from Morgan Stanley on China's investment merits.

If they're right, I figure it's okay to be a pig for a while, but with the usual caveat. If you're an investment sissy -- someone scared stiff of danger, quick, hefty losses and extreme volatility -- I would limit my flirtation with China to chow mein and an egg roll at your local Chinese restaurant. The reason: Even though you've got a shot at raking in big bucks in the Chinese stock market, in order to get your mitts on them, like Luca Brasi in the Godfather, you could wind up sleeping with the fishes.

That, in effect, is what investing in China, the world's fastest galloping economy (which grew 7.1% in the first 6 months), has turned out to be. In other words, giant gains marred by sudden and swift giant losses.

The numbers tell the tale. Last year, for example, the roller-coaster Chinese market, stung by a skidding U.S. economy, dived nearly 50%. This year, though, the market has turned out to be a bonanza, soaring around 80% on the back of its country's rebounding economy. Indisputable evidence of that powerful economic rebound is the recent revelation of China's sizzling second-quarter GDP growth rate of 7.9%.

Although he's gung-ho on China, Sagami, editor of Asia Stock Alert, an investment newsletter out of Bigfork, Montana, hoists cautionary flags. "China is for big boys only," he says, "because 20% corrections are as common as the common cold. So investors with an old ladies' mentality," he observes, "should stick with utilities."

Still, he offers some compelling reasons why he thinks China, which boasts the world's largest population at 1.4 billion, continues to makes a lot of investment sense despite the big market gain. For starters, he, like Morgan Stanley, sees economic growth continuing to barrel ahead, with China's GDP growth running 8% this year and 9%-10% in 2010. (In contrast, Morgan Stanley expects U.S. GDP to retreat 2.6% this year and grow 2.2% next year).

Sagami also points to China's "zooming profits," which he pegs as a 30%-plus grower in 2009, and a similar annual grower over the next five years.

One big plus, our Chinese bull tells me, is China's $586 billion stimulus package, which, he notes is working like a charm. Partly, he says, this reflects the fact China didn't have to borrow any money. Likewise, he notes, it spent the money on key, productive infrastructure projects instead of bailing out failing banks, shaky insurance companies, greedy brokers and antiquated auto makers.

Yet another significant plus is the 28% growth in money supply in the first six months, which is additional fuel for economic growth.

While Chinese exporters have lost a lot of business to the U.S. and Europe, its Sagami notes that its Asian neighbors, such as Dubai, Australia, Japan and a host of Mideast countries, have picked up the slack and some are buying like crazy.

Given China's solid growth prospects, Sagami contends U.S, investors are woefully underinvested in Asia, largely, he believes, because it's difficult to invest there. But they're wrong, he says, noting that there more than 120 Chinese companies listed on the Big Board and Nasdaq, as well as exchange-traded funds. Three of his favorite Chinese-oriented ETFs:

--iShares FTSE/Xinhua China 25 Index (symbol FXI): It consists of 25 companies that represent the largest 25 Chinese companies listed on the Kong Stock Exchange.

--PowerShares Golden Dragon Halter USX China (PGJ): This index consists of 103 Chinese companies whose common stocks are publicly traded in the U.S. A formula is used that prevents the biggest market-cap companies from becoming too large a component of this index.

--SPDR S&P China: This index consists of the largest 342 companies that are publicly traded and domiciled in China.

Asked how he could conceivably recommend a market that's already up 80% this year, Sagami observes that when something is up 80% in China, it's usually a precursor of subsequently rising as much as 200%, 300% or 400%.

His two favorite individual Chinese stocks -- both traded on the big Board and viewed as potential prolific performers -- are New Oriental Education and Duoyuan Water. Over the next five years, the sales and earnings growth of this duo are pegged by Sagami as 40% and 30% annually.

How would he compare the investment merits of the U.S. and Chinese markets?

You judge," Sagami says. "Does it make sense to invest in companies that are up to their eyeballs in red ink, that continually beg for government bailouts to stay afloat and that are hamstrung by the same politicians who control those bailouts? Or companies that are run by hard-working Chinese entrepreneurs who live and die with their companies?"

At Morgan Stanley, its Chinese economist Quing Wang has substantially raised his 2009 and 2010 GDP forecasts from 7% to 9% for 2009 and from 8% to 10% for 2010. Although the market is already pricing in a strong recovery, he notes his forecasts are still below consensus, which, he says imply swift upward earnings revisions and optimistic market valuations. In turn, this further implies upside stock potential of another 35% from current levels.

The bottom line from our Chinese bulls: As far as putting your money to work in risky China goes, this could be the year the pig outshines the bull and the bear.

Email Dan Dorfman at [e-mail] .

Comments

[Skynet91]

I wonder how much the CCP paid these guys to shill investment in China? There is little evidence that the Chinese stimulus is "working like a charm" or that China can sustain growth--and I question the govt's figures--without more domestic consumption.
Also, why does the author find it necessary to attack US companies with all that stuff about "antiquated auto makers" and "companies that are up to their eyeballs in red ink?" What about the US companies that are run by hard-working American entrepreneurs that live and die with their companies?

[KillTheMessenger]

Why wouldn't China be able to sustain growth? They have a billion plus people who all dream about a middle class existence, just like the people in the US... So that's an internal market at least three times the size of the US...

No big deal. Google "Wirtschaftswunder" to learn how that worked for Germany after WW II.

[FogBelter]

The German culture and the Chinese culture are not analogous to one another, so your citation is meaningless.

[FogBelter]

Mr Dorfman, since China is a totalitarian state the Banks there do what they are told. There is no free market in China. Anyone betting on China is betting that the leaders of the country made the right call ... not that the Market forces prevailed. The Chinese government had a poor response to last years earthquake. There are large numbers of displaced Chinese workers returning to the countryside due to their jobs evaporating because of the economic downturn, and there are social stability issues starting to appear away from the urban centers. When governments fall in China it starts from social instability in the countryside. This $586 billion dollar stimulus package likely has more to do with self preservation on the part of the Chinese government than anything else. Capitalism for the Chinese government is a means to an end, not an end onto itself. If the Chinese Leadership find themselves in a position where Capitalism is a liability to them they, being a totalitarian regime, have latitude to change horses in midstream. I believe it is unwise to read the Chinese economy in Western terms, but we will know in time whether or not the China Bulls of Wall Street are accurately interpreting what they are seeing.

[KillTheMessenger]

Yawn... if you think there are no free markets in China, you obviously haven't been there. Wild East, baby, Wild East!

[JXJASON]

Thanks for letting us know that there COULD BE gains of 200, 300 or 400%.

That's like saying I COULD WIN the PA lottery tomorrow.

I, personally, like the Master Limited Partnerships ( MLP's ) that are now paying dividends of 6, 7, and 8%. Many of them are listed on US exchanges and Zacks.com has ranked BPL, APL, EEP, KMP, MWE, SXL, TCLP and others.

MLP's are the tortoises way to invest...s­low but sure.

But always remember to do due diligence.

I liked the comment on " old ladies " too. Many " old ladies " ( and old men too ) are much wiser than " young ladies and young men ".

Buyer beware!!!

[drkazmd65]

I agree,... although I have some YGE (not as much as I would like) around as well that I bought in March for ~$3.80/sha­re. That one is doing extremenly well.

Another good one (to me so far this year) has been NGLS, current dividend yield ~11%.