The Finance Professionals' Post

Book Review: Startup Asia

China is now the second largest venture market. India is third. Vietnam is quickly expanding. Now more than ever, rather than starting an entrepreneurship in the West, the newest generation of entrepreneurs are looking to the East. Many of the same venture investors that formed the original Silicon Valley are repeating these successful enterprises in Asia. Startup Asia: Top Strategies for Cashing in on Asia's Innovation Boom tells the dramatic story of how business start-ups have developed and boomed in Asia.

What's Really Going on with US-Listed Chinese Stocks?

In this report, we analyze the technical position of every US-listed Chinese stock with a market cap above $5 billion. Of these, nine are based in mainland China, three in Taiwan and two in Hong Kong. By far the best looking chart is China Petroleum and Chemical while PetroChina shares are stuck at resistance. The worst stock, from a technical perspective is the telecom provider in Taiwan, Chunghwa Telecom.

From a value investing perspective, we believe that the best time to invest in a market sector is when sentiment is extremely biased against it. Presently, in our view, US-listed Chinese stocks appear to be one of the most reviled investment sectors, and not without some cause. A series of frauds uncovered by diligent short-sellers, and halfhearted support in reforming fraudulent practices by Chinese regulators have undermined confidence in Chinese stocks. The most widely cited index of US listed Chinese stocks, the USX China Index, is off 42% from its October 2007 high but has more than doubled from its November 2008 low.

We believe that Chinese stocks, having fallen out of favor, will gain newfound interest by investors. Later today, [Ed. Note: This paper is dated February 14, 2012.] Chinese Vice President Xi Jinping will be visiting the White House. Xi is expected to become the Premier or head of the government later this year and the media are expecting that this visit will lead to a “reset” of US-China relations. There are concerns about a slowdown in the Chinese economy as global commodities prices rise, real estate prices weaken and some manufacturing at the margin is returning to the US. But the Chinese economy is still largely tied to the financial health of its largest customer—the US consumer—who appears to regaining his health after a long illness. So despite the concerns, there is a bull case to be made for the Chinese economy as well.

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We do not have a view as to whether Chinese stocks now represent a good fundamental value or how pervasive the fraud issues are. However, the key premise of technical analysis is that the charts represent “the wisdom of the crowds” or, in other words, the many market participants ranging from savvy short-sellers like Muddy Waters, large sell-side and buy-side firms globally, individual investors and corporate insiders collectively bring all their knowledge to bear in the setting of share prices, and those with the most conviction, and presumably best knowledge, have the most impact on price given the higher volumes they trade. So, stock prices tend to correctly reflect underlying fundamental value. So in this report we look at what the technicals are saying about US-listed Chinese stocks.

We begin with an overview of the major Chinese markets. Our focus is on mainland China, but it is impossible to analyze this market without considering the interrelated Hong Kong and Taiwan markets. The main stock exchange in China is the Shanghai Stock Exchange which trades two classes of stocks – A shares which are traded in Renimbi, and are limited to Chinese citizens and Qualified Foreign Institutional Investors, and B shares which are traded in dollars and available to global investors. The Shanghai Stock Exchange is 23% off its 52-week high and just 10% above its low having bottomed in January, so this may represent an interesting entry point for investors. In Hong Kong, the Hang Seng Index bottomed in September and has gained 29%. In Taiwan, the stock exchange is 19% off its high, having bottomed in December. The USX China Index of US-listed Chinese stocks also bottomed in October and is up 25% off its low. So investors are seeing something they like again in Chinese stocks. Overall, most stocks are at inflection points of breaking out to the upside. A positive catalyst such as a good visit by Xi or a Greek settlement could push these stocks significantly higher. But, in our view, it is definitely time to be looking east again.

–Barry M. Sine, CFA, CMT

This an exerpt from a white paper entitled, "What's Really Going on with US–Listed Chinese Stocks ?" by Barry Sine, CFA, CMT, Managing Director and Director of Research at Drexel-Hamilton. Click here to download the full report.

A Tale of Two Overhangs: The Nexus of Financial Sector and Sovereign Credit Risks

ABSTRACT

There has emerged in the Western economies a strong nexus between the credit risks of financial sectors and their sovereigns. We argue that this phenomenon can be understood in the context of two debt overhang problems: one affecting the financial sector due to its under-capitalization following the crisis of 2007–08; the second, affecting the non-financial sector, whose incentives are crowded out by high sovereign debt and anticipated future taxes. While the desire to resolve the financial sector overhang may make bailouts tempting, they raise the risk of exacerbating the overhang related to sovereign debt. Conversely, reduction of growth prospects due to sovereign debt overhang can make the financial sector riskier as it is highly exposed to sovereign debt both through direct holdings and indirectly through implicit government guarantees. We provide evidence on this important nexus, based on our ongoing research that exploits data on European bank and sovereign credit risks.

Recent Research: Highlights from February 2012

"Measuring and Modeling Execution Cost and Risk"
The Journal of Portfolio Management (Winter 2012)
Robert Engle, Robert Ferstenberg, and Jeffrey Russell

Financial markets are considered to be liquid if a large quantity can be traded quickly and with minimal price impact. Although the idea of a liquid market involves both a cost as well as a time component, most measures of execution costs tend to focus on only a single number that reflects average costs and do not explicitly account for the temporal dimension of liquidity. In practice, trading takes time because larger orders are often broken up into smaller transactions or because of price limits. Recent work shows that the time taken to transact introduces a risk component in execution costs. In this setting, the decision can be viewed as a risk–reward trade-off faced by the investor who can solve for a mean-variance utility-maximizing trading strategy. Engle, Ferstenberg, and Russell introduce an econometric method to jointly model the expected cost and risk of the trade, thereby characterizing the mean-variance tradeoffs associated with different trading approaches, given market and order characteristics. They apply their methodology to a novel dataset and show that the risk component is a nontrivial part of the transaction decision.

How and Where Should You Invest in Emerging Markets?

As the new year failed to ring in a solution to the debt crisis that has transfixed the eurozone, investors are left wondering whether now is the time to place their bets on potentially risky growth opportunities or to keep their assets in safe havens. Beyond Europe’s sovereign credit issues, other factors such as massive debt overhang, the threat of double-dip recessions, and ongoing money printing by central banks in the developed world call into question the traditional definition of “safe.” In this environment, some money managers are asking whether investing in emerging economies may, in fact, be safer than committing assets to developed markets.

Majority of US Finance Professionals Expect the Global Economy to Stagnate or Deteriorate

Is it time to stop thinking globally, and to start focusing locally? That’s more or less the consensus among more than 3,700 professional accountants who believe not only has international trade continued to dry up, but that the global economy will continue to erode while those industries that focus domestically will inspire greater confidence.