Attention Investors: What's Really Happening in China

from PROFIT CONFIDENTIAL

October 21, 2009

In Today's Issue: Attention Investors: What's Really Happening in
China... Why Timing Is Everything in Equity Speculation... What
We Really Need to Keep the Stock Market Rally Going

** Attention Investors: What's Really Happening in China
-- The Financial World According to Inya Column, by Inya Ivkovic,
MA

According to the International Monetary Fund (IMF), in about 40
years, China's share of the global economy could triple, exceeding
what is currently the U.S. share of 22%. Taking the lead is not
something new for China. Back in the 1800s, just before the
Industrial Revolution in Europe and before the Americas rose in the
world, China's share in the global economy was a whopping 30%.
What subsequently led to China's fall in global rankings would bring
down many a Goliath, such as brutal Japanese subjugation during
both world wars and even more social and literal savagery under the
rule of Chairman Mao.

And yet, today's China is playing such pivotal role in the world's
new order, which is a testimony to the country's historic resilience.
For example, only 15 years ago, the manufacturing sector in China
was not even one-fifth the size of that of the U.S. Today, it is about
two-thirds and continues increasing. Furthermore, IMF statistics
reported a fairly dramatic increase in China's gross domestic income
(GDI), which, on an annualized basis, averaged $3,180 in 2008,
compared to $350.00 in 1990. What this meant to China is that, out
of a billion Chinese people, one-third got "promoted" into middle
class in less than two decades.

This is not to forget that China is still a communist country, just as it
has been for 60 years now. However, today's leaders are more
focused on market and private-sector reforms than on socialist
rhetoric. As a result, China's economy has become almost
miraculous, particularly by Western standards. But achieving
miracles appears easier than sustaining them. The biggest worry for
Chinese leaders now is how to keep on creating massive numbers of
new jobs, so that the remaining two-thirds of its population could
also be elevated to the middle class.

What is driving China's income growth? First, the country has
organized a mass migration of workers from rural parts of the
country to the big cities by building factory after factory. However,
the Great Recession has cost China quite a chunk of jobs; 30 million
to be precise. To add more problems, about 20 million university and
trade school graduates have started looking for work this year,
resulting in 50 million urbanites on unemployment lines.

Getting the economy back on track is not China's only problem.
China's industrial miracle was predominantly fuelled by thermal
coal, or the so-called "dirty" coal. Every year, China consumes about
2.6 billion tons of coal, which has produced an airborne, toxic soup
of gaseous emissions and unfortunately "caught" wind all the way to
the west North American coast.

And, while the world is pressuring China to clean up its act, literally,
Chinese citizens are also angry. They are angry with corrupt
government officials who have allowed the cities to pollute the
farmland and drinking water. Long gone are the days of the
Tiananmen Square massacre, when ruthless military action was
enough to squash a student uprising. If a billion Chinese were to
raise their voices against failings of the local officials and the Beijing
government, there would be no military solution to this and the
Beijing powers would be wise to understand that.

In the aftermath of the Great Recession, China must also rebuild its
own consumption levels to offset as much as possible the loss of
export to consumers in the West, particularly to the U.S. That is
easier said than done. The Chinese are inherent savers, which was
brought on by generations and generations of poverty. Additionally,
there are no social programs in China to protect its citizens when
they become ill, lose their jobs or are simply too old to work any
more. Scarred like this, no wonder the Chinese are reluctant to visit
malls more often.

While China's exports declined by 25% in the past year or so, the
country's economy still managed to grow. But that was largely
attributable to the government's stimulus spending. Eventually, the
stimulus taps will dry up. But, unlike the U.S., China has enormous
financial staying power. Just to put things in perspective, China's
foreign reserves currently stand at $2.0 trillion, while the U.S.
national dept is approaching $12.0 trillion! Racing towards the
global leadership torch, China's huge home advantage just might
make the final difference.

** Why Timing Is Everything in Equity Speculation
-- Ahead of the Street Column, by Mitchell Clark, B. Comm.

There is a lot of bandwagon investing going on right now and it's a
case of people trying to buy high and sell higher. The broader market
is trading on the earnings news of the day, but I can't escape this
feeling that we're due for a major retrenchment in stock prices. In
fact, we've been due for a major pullback since early September.

The single most attractive area of the stock market for speculators
remains U.S.-listed Chinese stocks, but the pickings now are slim in
my view. While this area abounds with opportunity, virtually all of
the good companies have already appreciated dramatically in value
on the stock market.

There still is a risk premium associated with U.S.-listed Chinese
stocks and you can think of it in terms of a lower earnings multiple
compared to domestic companies. One thing that's quite striking
about public Chinese companies is that many are exceedingly
profitable. You would think, therefore, that the Street would attribute
a higher valuation to these companies. But, there is a price for being
a foreign business in a developing country.

Successful Chinese companies tend to be exceedingly profitable
because their labor pool is so vast and inexpensive. Also, a lot of
customers in the Chinese economy tend to be well-heeled
government agencies or government-related entities. There is a lot of
money floating around China and a lot of it goes right to the bottom
line. This is why an equity speculator must pay attention to this
sector of the market.

So, we're left with the question: should investors take on new
positions right now? In my view, the answer is no. A trader can
certainly try a few momentum trades in some select positions, but I
think that investors should now be sitting on the sidelines. Anything
could happen to the stock market going forward.

Historically, stocks can do really well in the fourth and first quarters.
But, this year has been so wacky. The stock market could collapse
again, do nothing, or keep going higher. There is a reasonable case to
be made for any eventuality. If it's one thing I've learned over the
years, it's that major wealth creation from the equity market has a
tendency to occur in quick, short waves of enthusiasm. In spite of the
fact that the main stock market indices are down from their previous
levels, there has already been some tremendous upside since March.

In my view, the big money has already been made. Right now,
investors who took on new positions after the financial crisis are in
full reaping mode. Now isn't the time to be sowing new investments.

** What We Really Need to Keep the Stock Market Rally Going
-- Calling the Trend Column, by George Leong, B. Comm.

This market looks like it wants to move higher, as shown by the
trendline. The break by the DOW at 10,000 was psychologically
important, but it is not a big factor, as it has been broken on many
occasions. What are continuing to drive the current rally are some
strong earnings, especially from the technology sector, which
continues to provide leadership.

Earnings have been strong so far. Of the approximate 61 S&P 500
companies that have reported, about 79% have exceeded EPS
estimates.

We have seen impressive results from Google Inc.
(NASDAQ/GOOG), Apple Inc. (NASDAQ/AAPL), and Intel
Corporation (NASDAQ/INTC) to name a few. But, while earnings
continue to beat estimates, there also continue to be mixed results on
the revenue side, as there are shortfalls due to the slowing economy.
Earnings have largely been exceeded due to aggressive cost-cutting
and downward revision in earnings estimates. My opinion is that this
cannot be sustainable and we need to see revenues grow in order to
justify the stellar rally in stocks that we have seen.

It seems that the big market leaders are doing well, taking market
share way from the smaller players. Buying the "best of breed" in a
sector remains an excellent way to invest for those who are less
speculative. Over the long term, the top companies like Google,
Apple and Intel will continue to be market drivers in their respective
areas.

At the same time, you should be careful, as markets have come a
long way from the March lows. You've got to wonder about the
sustainability of the current rally. I get a sense that, as markets trend
higher, they will become increasingly vulnerable to selling if any
major bad news surfaces. There is a lot of growth and good news
discounted in this market.

We are also beginning to see euphoria on Wall Street with the bulls
and in the media. We are seeing some eye-pooping price targets on
some highflying stocks. Google was given a $750.00 price target by
Canaccord Adams. Just think back 10 years; remember that we saw
similar outlandish price targets given: just like the DOW 20,000,
which was believed back then to be achievable.

At the end of the day, markets continue to trade at multi-year highs,
with about 92% of all U.S. stocks above the 200-day moving average
as of October 19, up from 90% a week earlier and in line with 92% a
month ago. The same goes for the shorter-term moving averages. We
continue to see stocks hit new 52-week highs and this is reflected in
continued bullishness in investor sentiment.

At this point, continue to watch earnings as they pick up this week.
Watch the guidance going forward.

Markets are at a pivot point. For the rally to continue, earnings and
economic data will need to continue to be positive.