Health support for China investors
By Peter Navarro
Investment guru Jim Rogers recently issued a "buy" call on the beleaguered
Chinese market, where the mainland's benchmark CSI 300 Index is down more than
50% from its all-time high last October. The obvious question is whether this
market has hit bottom and is now the time to buy?
The best way to analyze any market is to put it through both a fundamental and
a technical analysis. On the fundamental side, China's economy remains robust.
However, inflationary pressures continue to build, and the twin specters of
higher interest rates and a strengthened currency hang over both the Hong Kong
and Shanghai exchanges.
The Chinese government has yet to raise interest rates this year
after increasing them six times in 2007 as it sought to cool the economy.
Inflation in the first five months of this year was running at 8.1%, and while
gains in the consumer price index slowed in May to 7.7% from 8.7% in February,
producer prices rose in May at their fastest in more than three years,
according to a Bloomberg report.
Higher interest rates would cut a wide swath of damage across the entire market
and take a particular toll on interest rate sensitive sectors like financials.
A stronger yuan - it has appreciated about 6.5% against the US dollar so far
this year, approaching its gain for the whole of last year - harms China's
export industries. However, a stronger yuan also helps the profit picture of
all Chinese companies on the cost side because it makes manufacturing inputs,
including oil and commodities such as steel and copper, cheaper. The bottom
fundamental line, then, is that a bearish cloud with only a slightly bullish
lining continues to hang over the Chinese market.
From a technical analysis point of view, the news is not much better. Since its
October 2007 high, the Chinese markets have suffered from a classic parabolic
fade symptomatic of a collapsing bubble. In many ways, this parabolic fade
looks like the collapse of the US tech bubble, but it is worse in at least one
important way: inexperienced individual Chinese investors have exhibited even
more panic-like behavior than those who came late to the tech bubble in 2000.
China's parabolic fade was set up by a huge market run-up between June of 2005
and October of 2007. During that time, the Shanghai market rose close to 500% -
a surge roughly double that of both the US tech bubble in the 1990s and the
Nikkei's bull run in the 1980s.
At this time, all of the usual technical indicators point to a continued short
sell of the market. An excellent bellwether is the exchange-traded fund FXI.
This ETF is based on the Xinhua 25 index, which tracks the 25 largest Chinese
companies available to foreign investors.
Both the 50-day and 200-day moving averages of FXI are falling. In addition,
the up/down pattern of volume shows that this ETF is under distribution rather
than accumulation. The chart pattern itself shows a weak downward trend while
the moving average convergence/divergence or MACD indicator is bearish. Note
that these technical conditions are present in two other market bellwethers -
EWH, which is the exchange-traded fund for Hong Kong, and PGJ, which is an
index comprised of US-listed stocks that get a majority of their revenue from
China.
With both fundamental and technical analysis signaling a bear market, does all
this mean you should stay out China? Not necessarily. In cases where any market
is flashing bearish signs from both a fundamental and technical perspective,
the best way to trade the long side of that market is to find stocks in sectors
that are relatively insensitive to the business cycle and for which you can
tell a good story about a strong upward secular trend. In fact, buying such
stocks in a downward trending broad market can provide you with some excellent
entry positions because the overall trend is depressing prices.
One sector that is both relatively immune to the business cycle and has a nice
secular story to tell is health care. The secular story rests on the
observation that China's healthcare system is in shambles. The problem is that
China's once-vaunted universal healthcare system has been systematically
dismantled as part of the country's move to privatize its economy. As a result,
China spends only 6% of its gross domestic product on health care. This
compares with 8% in Japan and fully 14% in the United States.
In today's China, there is an extreme shortage of doctors, and sick people are
forced to pay for their health care upfront. Those lacking the means to pay are
cast out of hospitals and left to die an often slow and painful death. A big
part of the problem is the cost of medical insurance - $50 to $200 per year -
in a country where the annual per-capita income for the vast majority of the
population remains well below $1,000.
Under China's privatized model of medicine, hospitals, pharmacies, and even
doctors have been turned into "profit centers" expected to finance their
activities through patient fees. As a result, hospitals and pharmacies
ruthlessly mark up the prices of medicines by as much as 20 times their cost.
Doctors then radically overprescribe drugs and get their kickbacks from these
hospitals and pharmacies. And as a result, more than half of what Chinese
patients pay for health care is devoted to pharmaceuticals alone.
This is an astonishing statistic when compared with the roughly 15% average in
most of the developed world. As yet another symptom of the corruption endemic
in China, many sick people also find that the only way to get proper care in a
hospital is to offer so-called "red-envelope" bribes over and above their
already exorbitant fees.
From this mess, one can glean at least two types of investment opportunities.
First, to quell rising political discontent, the Chinese government is clearly
going to have to dramatically increase its healthcare expenditures. That's
going to bootstrap the entire healthcare and pharmaceutical sectors.
Second, with the support of the government, private hospitals and healthcare
providers are already stepping into the breach to cater to the middle classes
and Chinese elite. As an illustrative example, one company seeking to leverage
this trend is Chindex International, symbol CHDX. It is opening both hospitals
and clinics staffed with foreign physicians and seeking to charge top dollar
for its services.
Another company is Biofield (BZEC), an over the counter stock. Biofield
recently signed a deal to provide its breast cancer technology to a healthcare
network in China and appears to be enjoying some technical strength from the
deal. These are the kinds of opportunities that are going to pop up more and
more in China - and there will be a ton of them.
In addition to healthcare, the whole biotech space in China is exciting. It not
only offers a good secular story. Biotech stocks are also generally driven not
by the business cycle but rather by news about the progression of a company's
new drugs through its pipeline to market.
In fact, there is an ongoing mass exodus of the American biotech industry to
China. The lures of China include not just far lower costs associated with the
research, development and testing of new drugs. There is also a far laxer
regulatory environment, which allows more aggressive and timely testing.
As a very interesting note here, the US Food and Drug Administration and China
recently agreed to allow the FDA to open three offices in China before the end
of 2008. Effectively, this office will serve as a regulatory liaison between US
biopharma and China.
Perhaps the safest way to play the China trend in biotech, given transparency
issues associated with the Chinese market, is to invest in US companies that
are joint-venturing with China. As an illustrative example, one such company is
Alpharma (ALO). This US-based generic drug company just signed a big deal with
Zhejiang Hisun Pharmaceutical to manufacture Vancomycin and retained its right
to be the majority party. (Vancomycin is an antibiotic traditionally used as a
"last resort" to treat stubborn infections.)
Still another variation on this theme is offered up by the recent collaboration
between Covance (CVD), and WuXi PharmaTech (WX). These two companies will
partner up on a toxicology lab. Of course, the second way to play this trend is
to directly invest in Chinese biotech stocks. An interesting play here is China
Sky One Medical (CSY). It has been very aggressive in adding new products, both
through internal generation and by acquiring other companies.
From an investing point of view, just remember two things in trading any of
these stocks. The Chinese market is in a bearish downtrend and biotech stocks
are very volatile. So don't jump into any stock with both feet. Instead, nibble
around the edges and build a winning position.
Note:
The author holds a position in Biofield (BZEC).
Peter Navarro is a business professor at the University of
California-Irvine, a CNBC contributor and author of The Coming China
Wars. (FT Press). His free weekly investment newsletter appears at www.peternavarro.com.
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