The Top 10 Reasons Why the China Sell Off Will Continue

by Louis Basenese, Advisory Panelist
Wednesday, September 2, 2009: Issue #1082

How much are you willing to pay for good advice? And by “good,” I mean profitable.

A couple of hundred bucks? A couple of thousand?

Before you answer, consider this: Two weeks ago, I alerted members of The Oxford Club to the precarious position of Chinese equities. As I put it, “China could be on a crash course with a correction.”

A contrarian stance, no doubt. But vindication came quickly.

The following Monday, Chinese stocks (represented by the Shanghai Composite Index) suffered a 5.8% drop – the worst single-day decline of the year. Two days later, they got dented by another 4.3%.

Unabashed China bulls will point out that the Shanghai index promptly recovered. But then this week hit…

Rally Rebuffed: Chinese Stocks Take Another Tumble

On Monday, the Shanghai Index plunged 6.7% – the worst one-day decline since June 2008.

My point? If you’d merely trimmed up your stops on Chinese stocks, my warning could have saved you thousands of dollars (depending on how much you had invested).

Or you could have traded China short – perhaps buying puts on the most widely traded China ETF – the iShares FTSE/Xinhua China 25 ETF (NYSE: FXI) – and pocketed a quick 20%-plus gain.

So again, how much are you willing to pay for good (read: profitable) advice?

While you think about it, let me tell you why I’m convinced the China sell off could continue.

My Top 10 Reasons Why China is Still Headed For a Correction

As I shared with Oxford Club members, here are my top 10 reasons China was and is still headed for heavy selling…

#1: More Froth Than a Starbucks Cappuccino:

To say Chinese stocks were slightly overvalued is… well, an understatement.

Last fall, Chinese stocks traded at 12.9 times earnings. After just eight months, they rallied to trade at 38 times earnings. Again, a cooling period is necessary to at least give the “e” time to close the gap on the “p” in the price-to-earnings ratio.

On a price-to-book ratio basis, the story’s no different. Of the 1,739 Chinese companies trading on the Shanghai, Shenzen and Hong Kong exchanges, the average price-to-book ratio is 5.02, compared to 2.1 for the S&P 500.

#2: We Can’t Trust the Chinese Government:

I’m not a conspiracy theorist. There’s just no incentive for a communist government to be truthful. So while the official GDP forecast from Beijing hovers around 8%, I’m not buying it.

Neither is perennial pessimist, Marc Faber. He says China is only growing at 2%. A bit extreme. But Chinese citizens don’t exactly convince me to think otherwise. For example, this recent survey reveals they trust prostitutes more than politicians.

#3: Lemmings Marching in Lockstep:

A recent Bloomberg poll of investors and analysts reveals that darn near everyone (70%) is bullish on China. As Humphrey Neill put it in The Art of Contrary Thinking, “When everyone thinks alike, everyone is likely to be wrong.”

#4: Foreign Speculators:

American investors aren’t just feeling bullish… they’re acting bullish. So far this year, they’ve poured $10.6 billion into emerging market mutual funds – a whopping 34 times more than the total amount invested in U.S. funds.

The bulk of these funds are going to China either directly or indirectly, as most emerging market funds are heavily overweighted to China.

#5: Domestic Speculators:

The bullishness is spreading like wildfire within China, too. In mid July, Chinese investors opened 484,799 stock brokerage accounts in a single week! That’s the equivalent of almost two accounts for every man, woman and child in Orlando, my city of residence.

As one strategist in Shenzhen remarked, “The prospect of making quick bucks in the stock market is luring retail investors.” Why do neophytes always have to learn the hard way there’s no such thing as a “quick buck” in the stock market.

#6: “Insiders” Are Cashing Out:

The timing of IPOs is no accident. Companies try to “time” the market in order to fetch the highest price. And after strong debuts for China State Engineering Corp. and Sichuan Expressway Co., companies are lining up to hit the stock market.

Foreigners sense the opportunity, too. Billionaire Sheldon Adelson, owner of Las Vegas Sands Corp., is getting ready to sell shares of his Macau casinos so he can restart work on the $12 billion project that got mothballed in the throes of the financial crisis.

#7: Too Much Easy Credit:

The United States is the poster child for the ill effects of a country hopped up on easy credit. But China apparently believes it can handle the excess. Over the first six months of this year, Chinese banks lent out a record 7.4 trillion yuan ($1.08 trillion). Monetary tightening is inevitable – and we know how well that tends go over with the equity markets.

#8: Jim Rogers isn’t Buying the Bull Either:

This guy literally wrote the book on investing in China – A Bull In China: Investing Profitably In The World’s Greatest Market. But he hasn’t bought any Chinese stocks recently.

#9: A Ponzi Scheme That Would Make Bernie Madoff Jealous:

Wall Street analysts don’t usually buck the trend, but Morgan Stanley’s Andy Xie apparently didn’t get that memo. He claims that, “Chinese stocks and properties are 50-100% overvalued.”

He adds that the only thing pushing prices higher is the expectation of price appreciation, which in turn sucks in more liquidity. In sum, Xie says, “Chinese asset markets have become a giant Ponzi scheme.” As we learned with U.S. real estate, the appreciation stops when the liquidity dries up. That day is coming.

#10: The Writing is on the Wall Of China:

Over the past two months, we’ve witnessed multiple 4%-plus drops for the Shanghai Index. And we already know what happens when the China euphoria truly wanes. In 2008, the Shanghai index plunged by two-thirds.

This week’s sell off could signal we’re headed for another correction. And if history is a guide, it could be severe.

To sum it up in two words: Caveat emptor!

Chinese stocks got way ahead of the global recovery and are in dire need of a cooling off period before even attempting another bull charge.

Which leads me back to the question I posed a moment ago…

The Best Advice is Practically Free

How much would you pay for good investment advice, like the information I shared above?

Is $79 too much?

The truth is for hundreds of thousands of you that subscribe to Investment U, the answer is a deafening “Yes!”

Of the roughly 400,000 subscribers here, the overwhelming majority haven’t decided to join my colleagues and I and become members of The Oxford Club.

However, many people think nothing of spending hundreds, even thousands, of dollars to buy “hot” stocks that they think are trading at deep discounts. And that’s without any principal protection either.

Contrast that with The Oxford Club M.O., which practically gives away a steady stream of profitable investment ideas and recommendations – with a money-back guarantee, too.

In fact, over the past five years, the independent Hulbert Financial Digest has ranked The Oxford Club in the top five global investment newsletters out of the 200 that the publication tracks. That kind of long-term success cannot be fabricated.

As a member, you get benefits like:

  • Two newsletters a month, packed with expert opinions and battle-tested investment strategies.
  • Weekly portfolio updates.
  • Urgent investment reports on the most attractive and timely opportunities.
  • Discounted (or free) nights at our clubhouses around the world.
  • Educational seminars.

One good recommendation could earn you 10 times the cost of joining. If The Oxford Club were a stock, it would be trading at a deep discount!

And for $79 a year for our very best, most timely advice, we’re practically giving it away.

For more information on what The Oxford Club is, what we do – and how to scoop up the many profitable benefits that come with being a member – just go here.

Good investing,

Louis Basenese

Editor’s Note: Investing in China made millionaires out of roughly 24,000 Americans. And while many media outlets would have you believe the boom is still on – they’re wrong. The Chinese market, once the poster child of millionaire-spawning profits, is flat over the last 12 months. Fortunately for readers, we’ve discovered the next Index Most Likely To Make You a Millionaire.