1. US-listed Chinese stock structural bubble
(1). US-listed Chinese stocks have experienced a hike of overvaluation
From June last year to the end of April this year, in 10 months’ time, US-listed Chinese stocks experienced a significant price hike. Take iChinaStock Index (ICS30) for example,, the index climbed from 765.58 on Jun. 29, 2010 to 1266.02 on Apr. 29, 2011, a big rise of 65.37%. ICS30 is developed by iChinaStock.com of Snowball Finance to reflect the trend of US-listed Chinese stocks, as an example
CHXN, a Chinese stock index introduced by Nasdaq, has confirmed the hike of overvaluation of US-listed Chinese stocks. CHXN fluctuated upward from 165.79 on Jun. 29, 2010 to 244.45 on Apr. 25, 2011, a rise of 47.45%.
The following chart shows the overall performance of ICS30 and S&P 500. From the lowest point of 1022.58 on Jul. 2, 2010 to 1363.61 on Apr. 29, 2011, S&P 500 registered an aggregate growth of 33.35%, a rate significantly lower than ICS30’s 65.37% growth during the same period.
(2). Only a few sectors rose, TMT was the major pusher
a) TMT sector showed significant jump
Most US-listed Chinese stocks are TMT (technology, media and telecommunication), solar energy, education, medicine and health care, and pharmaceutical. As the following chart shows, during the upward trending process, TMT20, an iChinaStock index reflecting performance of TMT sector, ran parallel to ICS30. From 908.94 on Dec. 31, 2010 to 1250.72 on Apr. 25, 2011, TMT20 had an aggregate rise of 37.6%, higher than ICS30’s biggest growth of 29.93% during the same period. Further considering the fact that eight out of 10 biggest US-listed Chinese stocks are from TMT sector, TMT sector was the major force behind the upward trend.
b) Some sectors did not rise
This round of rise did not benefit all sectors. Take education, healthcare, and pharmaceutical sectors as an example. When ICS30 (purple curve in the following chart) and TMT20 (blue curve in the following chart) were rising and climbing to the highest level of the year, EDU10 (iChinaStock education stock index, green curve in the following chart) was tumbling and HCP10 (iChinaStock healthcare stock index, red curve in the following chart) maintained at the same level.
(3). Reason for TMT sector’s jump
We are experiencing a transformation from “PC + Internet” to “mobile terminals + mobile network.” The vast space of development for Chinese mobile network industry and some US-listed Chinese TMT companies’ optimism accumulated in the short term to trigger the formation of TMT bubble.
a) Rise of mobile network is changing ecosystem of the Internet
Kleiner Perkins Caufield & Byers (KPCB), a well-known American venture capital fund, issued a Mobile Network Trend Report in February indicating that with the popularity of mobile terminals and mobile network, Internet users and traffic started to grow rapid at the end of 2010 and global mobile data volume is expected to increase by 26 fold in the next 5 years. Different services, such as social, search and mobile, are beginning to intertwine among one another. Newly emerging social media represented by Twitter, Facebook and Zynga start to popularise and grow vigorously under the push of mobile network. In addition, mobile business is fundamentally changing users’ purchasing behaviour and triggering the development of mobile advertisement.
John Doerr, a partner of KPCB, summarizes the development of mobile network as “SoLoMo”, that is, social, local and mobile.
(From KPCB’s Mobile Network Trend Report)
b) China has vast space for development of Internet industry
Data from International Telecommunications Union (ITU) show that there were 1.8 billion Internet users by the end of 2009. Although China ranked the first with 384 million users, rate of popularity was just 29% and there was still big space for development. Number of Internet users in China grew at a rate of 29%, higher than American’s 4% and global average rate of 13% as well.
By the third quarter of 2010, rate of popularity of 3G communication in US reached as high as 47% and that of China was just 2%. But number of 3G users in China is exploding at a rate of 458%.
c) Chinese Internet companies benefit from the development of mobile network
With the development of social network, new media (online video), e-commerce and LBS, Internet industry in China has witnessed birth of public companies represented by Dangdang (NYSE: DANG), Youku (NYSE: YOKU), Renren (NYSE: RENN) and Sky Mobi (Nasdaq: MOBI). Traditional Internet companies represented by Sina (NASDAQ: SINA) and Baidu (NASDAQ: BIDU) are also introducing new businesses, such as Sina Weibo (Sina’s Twitter-like microblogging services) and Qiyi (an online video site controlled by Baidu). These new companies and new businesses have obviously benefited from the development of mobile terminals and mobile network.
d) Spread of over-optimism
From the development of the capital market, bubbles are the result of people’s over-optimism of prospect of new techniques and new applications in the short run. Railroad in the 1840s, automobile and radio in the 1920s, transistor in the 1950s, and personal computer in early 1980s and biological technology have brought people excessive optimism. New technologies enable people to envision prospects of the new world. Spread of the optimistic mentality make people think they can all benefit from their investment. Hence, here come over-investment and bubbles.
The round of TMT sector bubble was generated by similar optimism, which came from confidence of Internet’s role in social network, e-commerce, LBS and other areas.
(4). Whether TMT sector bubble will burst
a) TMT sector recently showed valuation drop
Since the price peak at the end of April, TMT sector began to show a major correction. By Jun. 16, in as short as 7 weeks, TMT20 dropped by 37.03%, from 1284.85 to 809.08.
Some stocks also showed a significant correction. Take Sina as example. The stock tumbled from $142.83 on Apr. 20 to $77.62 on Jun. 20, a drop of 45.66%. Renren, which was listed on NYSE this May, once shot up to $24 on its first trading day and closed at $18. After as few as 36 trading days, Renren broken its lowest record one after another and closed at merely $6.13.
b) We cannot harshly conclude that TMT sector bubble has burst
Even though TMT sector experienced a significant correction in May and June, we cannot conclude the sector bubble has burst based on this.
By Jun. 28, Baidu’s PE ratio and sales ratio have not dropped significantly compared with late April and were much higher than those of Google in the same period.
At the same time, Dangdang’s PE ratio and sales ratio were showing significant correction, after which, PE ratio was still at a relatively high level. In addition, according to StarMine data from Thomas Reuters, Dangdang’s PE ratio was 140 at the end of June and stock price had a premium of 200% over others of the same sector.
Youku also showed significant correction. But even after it, sales ratio was still much higher than that of Netflix. Youku, which has not yet turned profitable, has no data available in terms of PE ratio.
Let us look at Sina’s recent performance. Since late April, Sina’s continuous drop halted in mid-June and stock price shot back to above $100. On Jun. 29, Sina closed at $100.45 and registered a rise of 29.41% during 7 trading days. Year-to-date accumulated rise is still 45.96%. Compared with the close price of $34.95 on the same day last year, the rise is still as high as 187.41%.
According Thomas Reuters StarMine data, Sina’s price had a premium of 225% over others of the same sector.
2. Investment strategy for US-listed Chinese stock structural bubble
US stock market shows no phenomenon of “sectors take turn to fluctuate” as Chinese A share market does. This is especially so for US-listed Chinese stocks. This round of rise will not necessarily be ensued by another round of rise. Relatively low valuation level of some sectors (online game, photovoltaic, healthcare, for example) has virtually become a norm.
As for US-listed Chinese stocks, those with the biggest investment opportunities are Internet companies. The Internet industry is now in the important process of transformation and the structural change will bring new investment opportunities. Investors need to study which companies will benefit from the vigorous development of mobile network, social media and e-commerce.
In the meantime, we need to clearly understanding that the Internet 2.0 era will show situations of “winner takes all”. The competitiveness of an Internet company will be reflected by innovative business models. Simply copying others can hardly make one survive in the market. This is the biggest difference between Internet 2.0 and Internet 1.0, represented by portal websites. It is no longer important to have “largeness and comprehensiveness”. Having new products and new business models to grasp users’ need in a thinly defined market can make one put up his own hedge and manage to take in all the profits.
(By Yuming Wang, iChinaStock.com)
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