Investing in China via Hong Kong – Riding the Dragon with Less Risk

Author: Bill Witherell, Post Date: January 22, 2007

Shanghai stocks jumped 4.7% on January 15th, their biggest one-day rise in more than a year. This followed a $3.6 billion initial public offering (IPO) by the insurance company, China Life, the shares of which doubled in the first day of trading. Such developments are characteristic of the current high volatility of China’s mainland equity markets, Shanghai and Shenzhen, capping a year of exceptional gains. Is this the time to book those profits or are the Chinese markets likely to continue to be strong performers in 2007?

China’s markets certainly have become more frothy after their steep upward climb in the second half of 2006. They are likely to continue to be quite volatile (risky). Indeed, there are signs that a bubble may be developing in the shares that are sold only to domestic investors. Rightly concerned about possible overheating, the Chinese Regulatory Commission is said to be delaying approval of new domestic mutual funds. Such measured efforts to temper these markets’ exuberance should help avoid more serious market adjustments later on.

In contrast to the well established Hong Kong market, the Shanghai and Shenzhen equity markets are still very much emerging market exchanges. They are less liquid than more developed markets and are still in the process of bringing their regulations and practices up to international standards.

Cumberland continues to maintain overweight positions for China in our International and Emerging Market Portfolios. The reasons why we believe this strategy should add value are discussed in the remainder of this Commentary.

The Chinese economy is growing at a rate that outpaces the other major economies; that is why their stock market outlook for 2007 is bullish. The OECD estimates that China’s GDP growth will be 10.3% in 2007, following a 10.6 % advance last year. The economy is projected to accelerate to a 10.7% pace in 2008. Domestic demand is advancing at about the same pace, with strong growth in residential construction and household durable goods. Profits are said by the OECD to be “extraordinarily strong”.

In short, the Chinese economic boom shows no signs of faltering. One potential cause of a slow-down, a sharp easing in the US economy, is now looking increasingly unlikely. Non-economic shocks are, of course, possible, such as a bird flu pandemic. Last week’s unexpected and disturbing anti-satellite missile test illustrates how geopolitical developments always have the possibility of throwing well founded forecasts off-track. Investment managers need to monitor markets closely and be ready to react to unexpected developments

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