On China Life, Global Volatility, and ETF Picks for 2007

Here’s the reason. Last Monday, China Life announced that it was issuing domestic A shares to be listed in Shanghai and Shenzen. A shares are restricted to trading by Chinese citizens and a small number of foreign investors that have been approved to invest in domestic shares. China Life already has H shares listed in Hong Kong and American Depositary Receipts (ADRs) traded in the United States.

On Friday, China Life set a price range of 18.16 to 18.88 yuan per share, and expects the shares to list in Shanghai by January 11. Thanks to the massive run up in China Life’s stock price last week, this price range represents a 29% to 34% discount to the closing price of the company’s Hong Kong shares Friday of HK$24.35.

Here’s what you need to watch out for. Investment banks normally set the A shares’ IPO price at a discount to the H shares to give the A shares room to rise when they start trading. But the normal discount in such cases is closer to 10%, not the 29% to 34% currently priced into the market. So the current price in Hong Kong (and the U.S. ADR) appears very rich on that basis alone.

Nor is China Life exactly cheap at the IPO price which values the company at a P/E of about 39 times 2007 earnings. That means that China Life is already trading at a P/E of over 50 in Hong Kong and the United States.

Here’s the bottom line. There is a lot of speculative frenzy already reflected in the price of the shares of China Life you currently hold. That doesn’t mean the stock cannot go higher once it is listed in Shanghai in early January. But if it does go higher, it will do so for reasons that have little to do with valuation. Shanghai is known for being a highly speculative, retail driven market and the psychology has clearly shifted from fear to greed. Trying to predict market tops in this environment is a mug’s game. The best strategy is to place strict stop losses on your positions to lock in your current gains when the trend of the stock suddenly reverses. Sell your remaining options for a 528% gain, and move your stop to $114.50 to lock in your already significant gains.

Portfolio Update

Global markets were unusually volatile last week. The reason? Thailand. Thai shares plunged nearly 15% on December 19 after the central bank announced regulations restricting foreign capital inflows to curb the Thai baht’s appreciation. The authorities did a quick about face and quickly lifted the controls on foreign stock investment but retained the curbs on bonds and other debt instruments. The benchmark index promptly bounced back 11% the next day. These are the kind of shenanigans that make investors scream "fire" in the global investment theatre, and head for the exit doors all at once. Our stops in Israel’s Partner Communications (PTNR) as well as Philippine Long Distance (PHI) were hit immediately. The volatility spread to Latin America, and we hit our stops on Mexico’s America Movil (AMX) as well as our Chinese NASDAQ play Mindray Medical (MR) later in the week.

My overall assessment? Thailand’s clumsy actions are unlikely to send lasting ripples across the global investing pond. It will likely be viewed as a buying opportunity down the road. But it does underline how quickly global markets can turn — and how quickly investors are willing to pull the exit trigger at the slightest scent of danger.

This Week’s Picks

Although we are positive on global markets going into January, last week’s skittishness has made us look at some more stable global plays. This week we’re recommending big picture themes that will also appeal to those of you with more medium- and long-term perspectives going into 2007.

Pick #1. As an analyst, I question the fundamentals of many of the Chinese state-owned enterprises. As a trader, I cannot deny the strong momentum of the Chinese markets. And the safest way to play this momentum is with the iShares FTSE/Xinhua China 25 Index (FXI) ETF. Just under 40% of the ETF’s assets are invested in Chinese giants PetroChina Co., China Life, Industrial and Commercial Bank of China Asia, China Mobile, and Bank of China. This ETF is the only way you can invest in the newly listed Chinese banks, both of which are now among the top 10 globally in terms of market capitalization. So buy FXI at market today and place your initial stop at $94.50. For additional upside, I recommend the May 2007 $105 calls (FJJEA.X).

Pick #2. With a flat tax and fast-growth New Europe economies in its backyard, the Austrian market has traditionally performed very strongly in Q1 of the trading year. Buy the Austrian ETF (EWO) at market and place your initial stop at $33.50.

Pick #3. The Swedish market has been Europe’s strongest in the last three months, powering ahead at an annualized rate of 80%+ since our initial recommendation in September. Although we were stopped out of this position based on some intra-day volatility last month, Sweden’s new-market-style reforms and sell off of government assets may make it the strongest European growth story over the next three years. Buy the Swedish ETF (EWD) at market and place your initial stop at $29.50.