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Bad News Is Good News: A Contrarian View Of China Investing

A Healthy Balance Between Monetary and Fiscal Support. Government to Remain Accomodative. Oil Sinks, Airlines Take Flight. When China celebrates its new year next month, we will transition into the Year of the Ram, also known as the Year of the Goat or Sheep. If you believe in luck, this could be a good sign. The ram comes eighth in the 12-zodiac cycle, and in Mandarin, “eight” sounds very similar to the words meaning “prosper,” “wealth” or, in some dialects, “fortune.” As you might imagine, the Chinese consider the number to be very lucky. But of course successful investing involves so much more than luck. In a time when not only China but much of the rest of the world is trying to get its groove back, it’s important to be cognizant of the factors that shape the markets, including changing government policy. We often say that government policy is a precursor to change, so it’s important to follow the money. With that in mind, I asked portfolio manager Xian Liang to outline a few of the most compelling cases to remain bullish on the Asian giant. Below are some highlights from our discussion. A Healthy Balance Between Monetary and Fiscal Support Back in October, I pointed out that one of the main contributors to the European Union’s sluggish growth is its inability to balance its monetary and fiscal policies. It has been eager to tax everything and everyone who moves. Waiting for European Central Bank (ECB) President Mario Draghi to act often feels a little like waiting for Godot. Investors’ patience is wearing thin. China, on the other hand, is much more responsive and actively committed to making full use of both policies in its arsenal to spur its cooling economy. On the monetary side, according to Xian, are interest rate cuts and a loosening of reserve requirements for certain deposits. The goal is to ease access to loans for businesses and individuals seeking to purchase big-ticket items such as homes. As a result, Chinese entrepreneurs have increasingly been able to start more businesses. (click to enlarge) Jobs growth has been so robust, in fact, that the government has managed to attain its job creation target outlined in its current Five-Year period ahead of schedule and by a wide margin. The country has grown millions of jobs with great efficiency, even as GDP sags. Although the Chinese housing market has stagnated in recent months, these new monetary measures will help it pick up steam. Already we’re seeing some improvement, with home property stocks moving higher. Regulations are an indirect taxation of the economy, whereas deregulation unleashes entrepreneurial spirit. (click to enlarge) On the fiscal front, the government is reportedly planning to spend $1.6 trillion over the next two years on infrastructure projects in various industries-300 separate infrastructure programs, to be exact, according to BCA Research. As I pointed out last month, many of these projects will largely involve high-speed rail, both domestically and abroad. China has already secured multiple construction deals with countries ranging from Brazil, South Africa, Nigeria, India, Russia, the U.S. and others. Government to Remain Accommodative There are a couple of reasons the Chinese government has accelerated support to capital markets, according to Xian: One, a significant deflationary threat has been driven by slumping energy prices. And two, there are potentially lower exports to commodity producing nations. Indeed, sluggish global demand has contributed to China’s weak December purchasing manager’s index (PMI), which dropped to an 18-month low of 50.1. China has been quick to respond to lower PMI data with a drop in interest rates. (click to enlarge) But Where There’s Bad News, Good News Is Often Not Far Behind The silver lining to falling commodity prices is that since China is a net-importer of raw materials-crude oil especially-the country has been able to save tremendously on its oil and gas bills. Back in November, I reported that for every dollar the price of a barrel of oil drops, China’s economy saves about $2 billion annually. From its peak in June, crude has slipped close to $50-you do the math. This has served as a major wealth transfer from oil-producing countries into China’s coffers. Oil Sinks, Airlines Take Flight Speaking of crude, declining oil prices-they’re currently below $50 per barrel-have been good for airlines, Chinese companies included. As you can see, there’s been a clear inverse relationship between crude oil returns and airline stocks. (click to enlarge) China is the largest investor in U.S. government bonds. The country has accumulated close to $1.3 trillion, so a strong dollar and falling oil prices benefit its economic flexibility. More middle-class Chinese might be able to afford to travel abroad, specifically here to the U.S., where inevitably they will spend their money. (click to enlarge) According to Carl Weinberg, founder and chief economist of High Frequency Economics: Chinese President Xi Jinping has estimated that there will be more than a half-billion Chinese tourists traveling to the West in the next 10 years. You can work out the impact if all of them came to New York and spent $2,000 or $3,000 each. That would be enough to add a half-percentage point to U.S. GDP every year over the next decade. Reasonable Stock Valuation Chinese stocks are currently valued below their own historical averages as well as those among other global emerging markets, making them both attractive and competitive. “Odds favor mean reversion to continue,” Xian says. “The better the Chinese markets perform, the more global liquidity they might attract.” Chinese stocks, as expressed in the MSCI China Index, are currently a much better value than those in the S&P 500 Index, trading at 10 times earnings whereas the U.S. is trading at 18 times. (click to enlarge) A-Shares Still a Huge Draw Chinese A-Shares surprised the market by breaking out last summer, having delivered 66 percent for the 12-month period. It looks like a breakout from the long-term bear market. (click to enlarge) What’s more, the upside is unlikely to have been exhausted. Although they aren’t as stellar of a bargain as they once were, they’re not yet overvalued, and retail and institutional investors might accumulate on pullbacks. For the A-Shares market, we have recently added exposure to A-Shares in one of our funds to capture more attractive valuation. In today’s environment, we believe the safer bets are investable H-Shares, which are driven by A-Shares and, in 2014, returned 15.5 percent. H-Shares comprise the vast majority of the fund’s exposure to Chinese equities, with further exposure gained through A-Shares exchange-traded funds (ETFs). The Ram Is the New Bull As GARP (growth at a reasonable price) hunters, we’re prudently optimistic about the upcoming year and anticipate great things out of the world’s second-largest economy. China’s government and central bank are committed to jobs and manufacturing growth as well as policy easing. Its stocks are reasonably valued, and low commodity prices should continue to offset slowing global demand. As Xian eloquently put it last month: China’s leadership appears to be delivering on the promises it made in November 2013 at the Third Plenary Session, specifically the liberalization of the financial sector and reform of the role capital markets play in allocating resources. This leadership is determined and committed to putting China on the right path. Past performance does not guarantee future results. Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio. The HSBC China Services PMI is based on data compiled from monthly replies to questionnaires sent to purchasing executives at more than 400 private service-sector companies. The MSCI China Free Index is a capitalization weighted index that monitors the performance of stocks from the country of China. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility. Fund portfolios are actively managed, and holdings may change daily. Holdings are reported as of the most recent quarter-end. Holdings in the China Region Fund as a percentage of net assets as of 9/30/2014: Air China Ltd. 0.00%, China Eastern Airlines 0.00%, China Southern Airlines Co. 0.00%. All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

Time In, Not Timing, Is Everything

Editor’s note: Originally published on December 22, 2014 Market timing can be a perilous game that long-term investors should avoid playing. It’s difficult to get it right. And the time spent on the sidelines waiting for “the right moment” presents big risks to your portfolio. Last week proved to be a roller-coaster ride for investors and an important reminder for investors to stay the course in the face of short-term market gyrations. Stocks dropped dramatically in the first half of the week, as the price of oil continued to fall and Russia raised interest rates in a desperate attempt to defend the ruble. That all changed on Wednesday afternoon, when the FOMC announcement halted the selloff. The announcement and accompanying projections appeared to soothe markets and actually change the mindset of investors, sending stocks sharply higher. Heading for the Exits Unfortunately, many investors had sold out of stock funds by then and missed that rebound. In fact, according to EPFR Global data, the week ending Wednesday saw the biggest outflows from equity funds since 2005. This is troubling because it shows that investors continue to let their emotions get the better of them. Moving in and out of the stock market based on the headlines is hazardous to the health of investors’ long-term portfolios, and puts financial goals at risk. In light of last week’s market tumult and the response from investors, I feel compelled to repeat the findings of a study published in early 2014 by my colleagues on the Economics & Strategy team at Allianz Global Investors. Their research shows the dangers of market timing. Specifically, the study looked at the performance of the Datastream US Total Market Total Return Index from 1973 through the end of 2013, comparing four different investment approaches: 1. Investing $100 at the start of the first year and adding an additional $100 at the start of each subsequent year. 2. Investing $100 on the day of the lowest index level of the year and adding an additional $100 each year on the day of the lowest index level of that year—the best day of the year to invest. 3. Investing $100 on the day of the highest index level of the year and adding an additional $100 each year on the day of the highest index level of that year—the worst day of the year to invest. 4. Investing $100 each year at the start of the year as in the first approach, but assuming one misses the returns of the best three trading days in each year. The results provide a strong cautionary tale: Time in the market beats timing the market. The returns are actually quite similar in the first three hypothetical scenarios, ranging from 11% to 11.9% in annualized terms. However, the fourth hypothetical produces dramatically lower performance: an annualized return of just under 1%. In other words, it doesn’t matter when you get in, it matters that you stay in for the long haul. Equally compelling are the results of Morningstar’s research on the disparity between mutual fund returns and mutual-fund shareholder returns. Over the 10 years ending Dec. 31, 2013, Morningstar found a widening performance gap between investors and the funds themselves. That makes sense given that investors became extremely risk averse in the wake of the global financial crisis, shunning stocks even as they rebounded. The scars from the crisis clearly run deep and have exacerbated investors’ emotional responses to market events. Breaking down the numbers, Morningstar shows that the typical investor gained 4.8% on an annualized basis over that 10-year period versus 7.3% annualized for the typical mutual fund. The gap is caused by the investor’s time (or lack thereof) in the stock market. In fact, market timing takes a bigger bite out of investor returns than fees for active management. Poor Timing Mutual fund flows in 2012 reveal the perils of market timing. Flows in 2012 Show Poor Timing 2012 Flows ($ Billion) Subsequent Return 2013 (%) U.S. Equity -93,677 35.04 Sector Equity 3,264 18.90 International Equity 13,604 13.19 Allocation 20,399 15.40 Taxable Bond 269,760 0.15 Municipal Bond 50,313 -3.40 Alternative 14,781 -4.85 Commodities 1,365 -9.10 Source: Morningstar. Looking ahead to 2015, we expect more market turbulence and rotation among different styles and asset classes. In this type of environment, it’s critical that investors remember the importance of developing a long-term plan in an emotional vacuum—and adhering to it even when the world around us seems to be panicking. In short, investors don’t plan to fail, but they often fail to plan. The key is to have a plan—and then stick with it. These are words to invest by as we prepare for 2015 and beyond.

2014 Commodity Exposure: Futures Vs. ETFs

Throughout the year, we track a simple strategy of buying the 12 month out Futures contract against the commodity ETFs that supposedly track those very same futures, to see just how the performance lines up; knowing that ETFs typically are the ones that underperform because of the contract roll. For more on how this looks long term, see our recent deeper look into the United States Oil ETF, LP (NYSEARCA: USO ) . But regardless of whether you’re tracking correctly – the concept of buying and holding commodities, whether it be via futures, or via ETFs via futures – isn’t proving to be all that great anyway, with an average performance of -7%, compared to the ETFs -11% (and -12% and -16% if don’t include Coffee). It was one of the worst years ever for long only commodities, with the PowerShares DB Commodity Index Tracking ETF (NYSEARCA: DBC ) falling -28% {Past performance is not necessarily indicative of future results}. We’re biased, of course; but we think the better way to have commodity exposure in your portfolio is a “Long/Short” Commodity Strategy; which profits from the rise or fall in prices. We’re talking about Managed Futures, which as a whole, had one of its best years since 2008 . {Past performance is not necessarily indicative of future results}. (Disclaimer: Past performance is not necessarily indicative of future results) (Disclaimer: Sugar uses the October contract, Soybeans the November contract.) Long/Short Ag Trader CTA = Barclayhedge Ag Traders Index) Now that you’ve read this, are you Bullish or Bearish on ? Bullish Bearish Sentiment on ( ) Thanks for sharing your thoughts. Why are you ? Submit & View Results Skip to results » Share this article with a colleague