Signs of Springtime in China?

by Paul Goodwin on March 26, 2015

This is an excerpt from Cabot China & Emerging Markets Report, which seeks to capitalize on the big boom in China and other emerging market countries. Editor Paul Goodwin, Cabot’s international investing guru, provides your passport to profits.

It’s risky to be optimistic in print, but sometimes that’s what the situation calls for.

We have noticed a confluence of factors that may have lasting positive consequences for emerging market ADRs, especially Chinese stocks. And while there are no guarantees, we are hopeful that the momentum could switch for the issues in our investment universe.

The first factor is the movement of the Golden Dragon Halter Fund (PGJ) that we use to track the intermediate-term trend of Chinese ADRs. The Golden Dragon has just staged a five-day rally (from March 17 through March 23) that pushed past its February resistance at 29.5 and gave us a new buy signal. While this is only a short-term trend, it’s the steepest move the ETF has made since October.

Keeping in mind that the Golden Dragon hasn’t made much net progress since October 2013, we have the possibility of a significant base of pent-up demand. And if the market gets used to the idea of the Chinese “new normal,” that demand could represent considerable buying power.

The second positive factor comes from recent European economic data. The latest purchasing manager’s index (PMI) for the eurozone was the strongest in four years, with both services and manufacturing booking stronger-than-expected expansion. Retail sales, especially in Germany and Spain, are causing spending to rise faster than at any time in the last 10 years. And Tuesday brought news that eurozone consumer confidence just reached a new eight-year high, reinforcing the idea that Europe is entering a cyclical recovery.

As we have been pointing out for a couple of years, the economic health of Europe is enormously important to the global economy. Taken collectively, Europe is China’s largest trading partner, and increased demand from Europe would give a boost to China’s export trade. China may be trying to lower its dependence on exports as the foundation of its economy, but having a healthy trading partner in Europe would be very advantageous right now.

The third positive factor that may support momentum is a resumption of Chinese IPOs and the possibility that the Chinese government might loosen its grip on future issues. In December 2014, Momo (MOMO), a mobile-based social networking platform and dating site (supported by Alibaba, which owns a 20% stake) came public. And this week, Wowo Ltd., a leading Chinese e-commerce service sometimes called “the Groupon of China,” is expected to come public on the Nasdaq exchange.

The possible policy change on IPOs was signaled by Premier Li Keqiang at the annual meeting of China’s parliament. Li said that the government intended to move toward a system in which market forces, rather than government approvals, would control the IPO process. While this policy is aimed at domestic Chinese listings, it’s likely that its effects will spill over into listings on U.S. and other global exchanges. And that’s all to the good.

While there is still considerable uncertainty about how China will manage its high corporate and provincial debt levels and its citizens’ overinvestment in housing, investors are always looking at least six months into the future, and their buying behavior is voting in favor of China’s success.

On a different topic, we have been following the progress of Alibaba (BABA) with interest. The stock fell from 120 in November to as low as 80 earlier this month, but it’s showing signs of putting in a bottom between 80 and 86, as it’s hovered in that range all during March.

The 33% haircut for BABA is partly the result of market trends (the Golden Dragon and BABA both peaked on the same day in November before starting their corrections) and partly a function of investors’ excessive enthusiasm during the IPO process.

We think the Alibaba story is intact, and we will be watching BABA closely for further technical evidence that the stock has put in a bottom and is beginning its recovery. 

A researcher and writer for over 30 years, Paul Goodwin has been a member of the Cabot investment team and chief analyst of Cabot China & Emerging Markets Report since 2005.

Subscriber comments on Cabot China & Emerging Market Report

Paul Goodwin can be found on Google Plus.