The View from a China Skeptic

07/25/2015 10:00 am EST

Focus: GLOBAL

Carlton Delfeld

Editor, The La Jolla Letter and Pacific Gains

Despite his caution that the China market is in a bubble, global investing expert Carl Delfeld, editor of The Blackthread Brief, also suggests it would be a mistake for investors to sell all their China holdings and discusses various ways for those looking to play the market in this environment.

Steven Halpern:  Our special guest today is global investing expert Carl Delfeld, editor of The Blackthread Brief.  How are you doing today, Carl?

Carl Delfeld:  I’m fine, thank you.  Nice to be with you, Steven.

Steven Halpern:  Well, thank you for joining us.  First, can you tell our listeners a little about The Blackthread Group?

Carl Delfeld:  Sure. We’re a business and investing, research and consulting firm and we’re focused on the Asia/Pacific region and emerging markets.  We also publish, as you mentioned, The Blackthread Brief, which is an investment newsletter.  

Steven Halpern:  Now, you’ve recently compared the China stock market to the dotcom boom in the late 1990s in the US. Can you explain that?

Carl Delfeld:  Sure. Well, both the tech bubble—our tech bubble—and what’s been happening in China over the last year are both pure momentum plays, meaning people get a bit carried away in investing in the tech stocks, and also in the last year, the China stocks, which, at one point, were up over 125% before their recent fall.  

One sign of this is, I’m sure we both have friends who, during the tech boom, dropped their job and became day traders, trading in and out of tech stocks.  The same thing has been happening in China.  

China is a new market, but there’s been a lot of anecdotal evidence about people just going a little bit nuts, losing their jobs, and trading Chinese stocks.  The amount of new accounts that have opened in China has been breathtaking. They now have 200 million stock traders, which is well more than the American investors in the US stock market.

Steven Halpern:  Now, you’ve suggested that the Chinese government is walking a tightrope here, in part balancing the desire to have strong markets that can help offset a weakening economy.  At the same time, could you touch on what’s perceived to be a tremendous amount of market manipulation going on by the Chinese government and how that impacts the whole situation?

Carl Delfeld:  Sure. Well, the bigger picture is—I have to be upfront about it—I’m a China skeptic. In fact, I just released another version of a report I put out more than two years ago called The China Skeptic.  It’s seven trends that are going the wrong way in China and why I think it’s not going to end nicely.  

To address your question specifically, China needs growth, economic growth.  As you know, they’re overall growth has been falling from double digits to seven.  I predict it’s probably around 5% now.  That’s probably not enough to generate 20 million new jobs a month, which is what they need.  

They’re trying to do anything they can do to generate growth.  The real estate market’s in a big bubble and they want to address that.  Their idea is to shift investment from the real estate market into the stock market, which has been in the doldrums for a couple of years.  

The problem is you just can’t control the stock market like you can do manufacturing and direct investment.  No question, they were shifting resources and attention to the stock market.  That’s why it was up so sharply before the recent fall.  Even in the fall, where it fell a breathtaking 30% in a little over three weeks, they were doing everything they could.

They stopped trading in half the stocks.  They pumped money into the stocks of the big state-owned firms.  They banned short sales.  You could see...it’s fruitless.  They won’t be able to manipulate the markets like they would like to.

Steven Halpern:  Now, despite your caution that the China market is in a bubble, you also suggest it would be a mistake for investors to sell all their China holdings. Could you help explain this apparent contradiction?

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Carl Delfeld:  Sure, sure.  Well, obviously, the best, a lot depends on when you bought into China.  My basic strategy in all these markets is to buy them when they’re out-of-favor—in fact, hated—and then in an upturn.  That’s when you can score big gains, which is why, more than a year ago, I said buy Chinese stocks, which were dirt cheap.  

On the other hand, the China stock market is going to be volatile, so you should be a market timer to a degree, but you can’t be a panic seller. That’s what I meant by that comment, meaning, depending on where you’re in, whenever you double, we take half the money off the table, at least, so you should have done that.  

You should have a trailing stop-loss.  You have to have a system in place. Usually we recommend a 15% trailing stop-loss so when stocks go down in a market 15% from their highs, you’re automatically out.  

The other thing is that China is going to be an up and down market.  To sell everything and hope you can time it perfectly is probably a mistake, which is why I recommend two things right now:  One is to look for high quality and one is to look at other ways to play the China market.

Steven Halpern:  Now, along the lines of high quality plays within the China market, you point to the consumer conglomerate Jardine Matheson (JMHLY). Could you tell our listeners about this company and explain the attraction you see for these shares?

Carl Delfeld:  Sure. Well, Jardine Matheson’s an outstanding company going back a couple hundred years.  They’ve been very active in all sorts of consumer plays throughout Asia, including China.  

The interesting thing is they’re sort of like the Johnson & Johnson if you will of China, in terms of their quality and tentacles throughout the economy.

I would say it’s a laggard. It’s down 12% this year, but it didn’t boom with the other high tech Chinese stocks.  It’s a laggard.  It’s cheap, about 10 times the earnings.  I really like that company.  

Steven Halpern:  Now you mentioned earlier that you’re also looking for some other ways to play the market in this environment.  Perhaps you’d be kind enough to mention another investment vehicle that might be of interest to our listeners who are seeking a longer-term exposure to China?

Carl Delfeld:  Sure. What I would look at is Hong Kong.  A lot of the Chinese companies trade on the Hong Kong Exchange through H Shares, they’re called H Shares.  If we really look at Hong Kong compared to the Shanghai market, the Shenzhen market in China, Hong Kong is very cheap.

The forward price to earnings ratio is less than eight times.  It’s selling for less than sales.  It’s trading just a little bit over book value and at a dividend yield of 3.5%, which sounds pretty good to American investors, I’m sure.  

I would nibble at it now.  I would definitely—if you’re going to reenter and want Chinese exposure—I would do it through Hong Kong.

Steven Halpern:  Now would it be best for the typical investor to focus on an exchange traded fund in that area or look at individual stocks?

Carl Delfeld:  There are some exchange-traded funds that track that index, but I’m also tracking some specific stocks as well.

Steven Halpern:  Again, our guest is Carl Delfeld of The Blackthread Group. Thank you for your time today.  

Carl Delfeld:  Thank you. I enjoyed it.

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