Selling The Pao Mo

Dr Steve Sjuggerud - Fri 26 Mar, 2004

"...They say they don't ring a bell at the top of the market to let you know when to get out. No, they don't. Yet to me, all five of these things above are the proverbial bell - very real indications that the boom in China-related stocks has peaked..."

- A waiter pulls my friend Porter Stansberry aside. "Psst...I overheard you talking about China...how can I get in?"

- A champion professional windsurfer (and friend) tells me, "I want to invest in China."

- Two China IPOs debut in the US (Linktone and Tom Online)...and both of them fizzle quickly.

- Shares of PetroChina soar on huge volume after having done absolutely nothing for many years. (The only real news was that Warren Buffett bought some.) After an enormous rise, both share price and the activity in the shares fizzle.

- Friend and journalist Andy Carpenter makes the cover of the Wall Street Journal section on investing for the successful launch of his "China Club", focusing primarily on small, China-related stocks. Andy honestly tells the WSJ reporter he hasn't been to China and has little China experience. "Don't look for me to give you a grand insight into China...My opinion is as good as anyone else's."

...They say they don't ring a bell at the top of the market to let you know when to get out. No, they don't. Yet to me, all five of these things above are the proverbial bell - very real indications that the boom in China-related stocks has peaked.

You know we're at the peak when the waiters and windsurfers want in and "China Clubs" pop up. And you know it’s running out of gas when you see the January peak in PetroChina and the two failed China IPOs.

I expect China-related shares to fall dramatically. Here's a piece of advice for you: if you own any China-related stocks, sell them now.

Don't get me wrong. I see what's happening in China. Of course I know that the economy is growing. And of course I know that China has completely changed the landscape in commodities, as its demand for raw materials seems insatiable.

So let me be clear - I am not "voting" against China. I am simply voting against China stocks. They've simply run too far, too fast. Everyone, including waiters and windsurfers, want in.

To me, that means it's time to sell.

Yet a huge pile of "hot" money has been flying into China. Which reminds me of something John Train wrote in one of his Money Masters books. It went something like, "You should ask yourself: Where is my money needed so badly that I can really get paid for sharing it if I can stand some risk and discomfort?"

I have remembered this phrase, and I've invested successfully based on it. Nobody, for instance, was investing in Iceland when I first wrote about it a few years ago. Nobody was buying Ecuador when I first wrote about it in 2000 (I wrote a few cover stories for the Zurich Club’s US newsletter on buying Ecuador back then), and the Ecuador stock market rose by triple-digits in dollar terms in 2000 and 2001.

Let me share a fact with you. At the end of January, the governments of China and Hong Kong together held a total of over $200 billion US dollars in cash and US Treasuries. Now, since China is directed by its government, let me ask you: Is your money needed badly in China right now?

Absolutely not. So the chance for you to really get paid in China right now is very low.

Just take a look at what has happened in previous "China manias". We don't have a decent history of stocks in China to draw from, but the next best thing is Hong Kong. Over the last 20 years, every time the P/E ratio of the Hang Seng Index (Hong Kong's version of the Dow) reached 20, Hong Kong stocks lost between a third and half of their value.

It happened in late 1987, and the index fell from around 4,000 to around 2,000 - a 50% fall.

It happened in January of 1994, and the index fell from around 12,000 to around 8,000 - a 33% fall.

It happened during the dot-com boom in 2000, and the market fell from around 16,000 to around 9,000, nearly a 50% fall.

Can you believe that it's happened again already? Yes, last month, the P/E of the Hong Kong stock market rose above 20. Time to sell.

China in 2004 really is like the Nasdaq in 1999. The waiters and the windsurfers are expecting astronomical returns. But they - and most investors - don't have a clue about what it is they're buying...and they'll likely end up disappointed.

You may have lost money in the tech-stock bust of 2000. Don't get burned a second time.


Regards,

Steve Sjugerrud,
for the Daily Reckoning

P.S. You don't make money buying what everyone wants. You make money by buying something when nobody else wants it...and selling when everyone wants it. I call it “Hold your nose and buy" investing...quite often, the more "stinky" an investment sounds, the greater its potential for profit.

Consider this...the list below is all the countries whose stock markets have risen by more than 100% total in US dollar terms over the last five years. There are only six markets, and they’re all in "stinky" places...

1. Russia
2. Pakistan
3. Czech Republic
4. Venezuela
5. Hungary
6. Indonesia

Meanwhile, if you had invested in the "safe" countries, you’d have lost money - for the last five years! Only a few markets in the world are down by 20% or more over the last 5 years...and many of them are in “pleasant-smelling” places:

The Nasdaq (down 20%)
The FTSE100 (down 20%)
Japan’s Nikkei 225 (down 23%)

In my experience, what appears most desirable is often the riskiest place for your money...and what appears risky is often an extraordinary opportunity.

Everyone wants to get in on China right now. That's why I think it's time to get out.