06 May 2008

Year of the Bear

Mark Hulbert commented yesterday in MarketWatch on John Dessauer's outlook on China. Hulbert covers investor newsletters, and John Dessauer is the editor of the straightforwardly titled Investor's World. Dessauer believes it's the year of the bear:

Does Dessauer consider Chinese stocks to represent a good value today, with the Shanghai Composite index trading at barely more than half its high set last fall?

In a word, no.

For starters, Dessauer is concerned about the speculative motivation of most individual Chinese investors in Chinese stocks, and what it would do to the prices of those stocks if and when they decide to pull out en masse. "The sixfold rise in Shanghai stocks happened at the same time that millions of new Chinese investors flooded into stocks," he pointed out. "At times, Shanghai stockbrokers were opening a million new individual accounts a week. Does anyone really believe these individuals are long-term investors?"

Answering his own question, Dessauer continues: "It will be interesting to see how all those millions of individual Chinese who rushed to buy stocks on the way up will react now that the market has fallen sharply. My guess is that many will lose interest in stocks and go back to work to earn back their losses."

In addition to being concerned about the speculative nature of the Chinese stock market, Dessauer also worries about the "lack of managerial talent in China. Mao killed or severely punished most intellectuals, or any talented people. An entire generation of managerial talent is missing in China. It takes a long time to create managerial talent. China has been making progress with education and training but the problem is still far from solved."

A third source of concern for Dessauer is "the difficult issue of guanxi, the intertwining of personal and business relationships, which leads to what we would call corruption or nepotism. In China, it has become ingrained that you combine personal and business relationships... I have visited many companies in China -- public, private and state-owned. The business culture is slowly changing, but it is still common to find high-level managers who do not know what 'profit' means, never mind shareholders. There is still a question about who owns what ... If you are still tempted to buy Chinese stocks, take a look at one or two prospectuses for Chinese companies. That is a sobering exercise that should curb your enthusiasm."
Let's quickly pick through Dessauer's concerns.

First, the Shanghai market does seem to still be Bubblicious TM, even with the 50% pullback. It's a fair assessment that the influx of new money from unsophisticated investors that followed the stellar Chinese market's performance could flee the market in a similarly spectacular fashion if Shanghai starts to look like the NASDAQ of the early aughts.

Second, I suspect the lack of management talent is more of a concern for investors looking at smaller Chinese companies. Since I'm focused on FXP, and the 25 largest Chinese concerns, I'm not sure the shallow management pool is as relevant for my bearish case.

Third, the nepotism issue probably concerns me as much as the management talent issue. Which means, not so much.

My main concern should be the Chinese government's attempts to put on its best showing in the run-up to the Olympic games on 8 August 2008. (The Chinese and their lucky number 8.)

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