China's Market Outperforms Itself

03/11/2009 11:11 am EST

Focus: STOCKS

Jim Trippon

Editor-in-Chief, China Stock Digest

Jim Trippon, editor-in-chief of China Stock Digest, says the Shanghai market has been the best in the world recently but Chinese stocks traded elsewhere have lagged.

Where is the best performing stock market in the world? At times like these most investors must be wondering if any market anywhere qualifies. Well, there’s only one answer: Shanghai.

The Shanghai Composite index has been gaining for five and a half months while every other indicator in the world has been slumping. Currently the SCI (Shanghai Composite Index) is hitting new [multimonth] highs, continuing a dramatic climb that began with the announcement of China’s trillion-yuan ($586 billion) stimulus program.

Hong Kong’s Hang Seng China Enterprises Index, or H-share Index, which tracks mainland-incorporated companies, is down for the year but up more that 11% from levels three months ago. That’s far behind Shanghai’s performance, which is up a stunning 45% from [its] low of approximately 1600.

[Nonetheless,] the iShares FTSE/Xinhua China 25 Index ETF (NYSEArca: FXI) is actually off more than 7% for the year. Going back five months, the FXI has moved in exactly the opposite direction of the SCI, [shedding] approximately 38%.

There are several reasons for the gap between Shanghai’s stock market and western markets for Chinese stocks. One obvious problem is the freefall in western markets, which is dragging down ADRs of quality companies like China Mobile (NYSE: CHL).

[Also,] some critics complain that Chinese authorities are flooding the nation’s economic system with money in an attempt to boost the economy. Critics warn that [another] bubble is developing in Shanghai, and they argue that there’s no place for all of China’s stimulus money to go except into internal stock market speculation.

[But others argue] that the Shanghai market is signaling a rebound in the Chinese economy. Although China’s GDP growth has been a world leader throughout the current recession, it did hit a low of 6.8% during the fourth quarter of 2008 and may be even lower during the first quarter of 2009. Nevertheless, China continues to grow while Western economies shrink.

Leading thinkers now say (almost universally) that “decoupling” [of China’s economy from the west, especially the US] is absolutely impossible. If America is in decline, China should be, too. The simple fact is that it’s not.

We’re currently seeing China-based companies that are blowing American competitors out of the water with stunning profit figures. Many have yet to be rewarded with big valuation increases on western stock exchanges.

Huge price differentials between parallel markets cannot endure forever. The difference in share prices of Chinese companies listed in both the Shanghai and Hong Kong has widened to an eye-popping 60%. That’s similar to the premium paid for Shanghai A-shares compared to ADRs traded in New York.

We’re looking for signs that ADRs of China’s blue-chip companies will stop slavishly following the index of US blue chips. When that time comes, Chinese shares will indeed decouple from their ailing US counterparts and realize their true value.

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