China Microcap Update...
There ended up being a slew of short term traders in China U.S. traded microcaps. Gains were big and persistent enough that many had profits. [nervous profits at that]
The group had been treading water before this week for the previous week or two.
Reaction to the slew of earnings reports had been very mixed indicating that much of the good news had gotten built in.
When a lot of momentum traders are involved, it's a game of musical chairs with each trader thinking he will beat the other guy into sitting in a chair when the music stops.
The music stopped Sunday night when the mainland Shanghai got hit for a 6% loss.
That combined with bad futures indicating a nasty opening for U.S. stocks.
The result was a serious gap down open for almost every China small cap stock as buyers had little reason to be aggressive and momentum holders felt en mass that the music had stopped and said "get me out now".
That imbalance between scarcity of buyers and wall of "get out now"sellers created the gap down open.
China small caps had for the most part risen to where they were not dramatically undervalued, so there was no particular reason for value buyers to immediately jump in.
The music has not started up again, so there is reason for momentum traders to jump back in.
The big problem is...momentum is not seen as up.
Prices have not gone down to the point where value buyers see overwhelming reward vs. risk.
Most of the go go momentum traders are out so that has decreased selling pressures.
Without short term momentum traders willing to go back in and prices not down far enough to represent exceptional value, there is not a lot of urgent buying from the value crowd, just some gradual chipping away on the buy side.
What remains is a standoff with a gradual downside slippage bias.
Where these stocks individually trade in 3-5 years will be mostly a function of their fundamentals at that time [within a wide P.E. range determined by prevailing optimism or pessimism]. For the higher quality China stocks that can continue their earnings momentum, the average of that range should be considerably higher than that of this years prevailing range.
Over the shorter time horizon of 6 months, as we have seen, these stocks can trade at pretty much any PE ratio trader psychology dictates and that includes prices that are silly low compared to their fundamentals.
One should keep in mind that value buyers in general are at one of the lowest representations in the style universe that has ever occurred.
Especially among the traders of China Small caps, those who buy on value are far fewer than those who play momentum.
Part of that is the internet which fosters a short term trading mentality and that is more conducive to momentum trading than value buying and holding.
[Plus we suspect...many of those trading today are not thoroughly schooled in determining valuation and what it really means].
We turned increasingly cautious on the market and this group in the 8 trading days before the Monday mini meltdown and executed many partial sales starting Aug 4th.
We had planned on executing more Monday and Tue of this week but the Monday opening mini crash was a pretty big markdown and beat us to the punch on the rest of the sales.
We had been advising. Sell when there are eager buyers, not when the tide has turned and there are few bidders and you are among a throng of sellers. We were even late in doing that with the balance of planned sales...it shows just how fast the situation can change, turning bidders into sellers.
In this case it occurred almost with the snap of the fingers.
Small Cap China stocks had been the best performing group from the bottom of the bear market to it's recent top.
We do not expect them to regain their leadership position shortly. [but one should recognize that big % givebacks have already occured, thus taking some of the future price risk out of the equation already].
The daily, weekly, even monthly dramatic fluctuations in their price will have little effect on where they trade in the long term.
Our feeling lately has been that gains were so great that it put the stocks "ahead of schedule" of where we thought they would be at this point.
We believe there will be some reversion to the performance mean for a while which should not be a surprise if they truly were "ahead of schedule".
This does not mean that none will go up. It's likely to be a mixed bag...we are only talking about the group taken as a whole.
We're not concerned about the majority of those we hold as most were core positions not intended for sale anyway, but we did want to sell enough around the edges to be able to scoop them back up at lower prices as individual opportunities inevitably crop up. We'll be able to do some of that but less than planned unless they get an unexpected rally which would allow us to lighten up a bit more.
The main acct hit it's yearly % gain high last Thursday. On Friday, we said that high would stand as the high for quite a while.
That prediction looks well on it's way to being correct.
Many lose sight of realistic expectations when gains are sizzling
10% annual gains on an account in this post yr. 2000 stock environment are excellent.
We saw small Cap china stocks go up 400 and 500% from the March bottom.
To show just how abnormal that is...
If China small cap stock ABCD is expected to double in 3.7 yrs., that means it's annual gain compounded is around 20%.
If the stock is $5 to start, to be on track, it would gain about $1 after one year going from from $5 to $6 a share. That means it's monthly gain not compounded would be around $.08....8 cents per month.
That can give one some perspective on:
1. Just how much wild sentiment "noise" is involve in short term pricing of these stocks [both euphoria and despair]
2. How a short term big gain steals performance for a while with likely reversion to the performance mean following.
Finally...we reiterate that for those higher quality China micro cap stocks that can continue their earnings momentum, we stated at the time and still believe that their low prices they traded at over the winter represented once in a life time opportunities.
We do not expect any correction they encounter will revisit those bargain basement levels ever again.
While .382 normal Fibonacci pullbacks in them from recent highs might seem brutal and give one the impression that something must be seriously wrong...givebacks like that are entirely normal in the context of the run they have had. There will be many steep sell offs on the way from here to there...There being much higher prices in a few years.
All IOHO of course,
Do your own DD.
Fabian
This is not a "recommendation" to do no buying of this group.
They are still a group of individuals, and one can be alert and take advantage of individual companies where one feels they have gotten to a "buy" point either through chart analysis, fundamentals, or both.
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