Rough Week for Chinese Small Caps
posted by The Traveller on Sunday, January 24, 2010

Many of you have been waiting for this and now we've got it. The first major correction in the general markets since October 2009. As far as I am concerned nothing bad has happened so far, quite the opposite actually: we are consolidating the huge gains of the last three months in an orderly way so we have room for further price appreciation.

The most positive scenario for next week is also the most likely. We are back in the November/December trading range between 1085 and 1110 points in the S&P 500. This area held for six weeks last fall and the 1085 level should provide good support. I do neither expect a massive drop (10% or more from current levels) nor a big rallye (as in continuing the run up of '09 in full speed) for this year. Rather the markets will act similar to what happened in 2004 when the setup was also a big crash (2001/02) followed by a huge rally (2003).

This will be a stock picker's market where fundamentally sound and relatively undervalued stocks will outperform both risky and speculative plays and also big cap market leaders. And those value stocks are exactly what I am looking for here with the China Model Portfolio.

There will be some volatility, bubbles as well as sell-offs on the way but I do fully expect that emerging markets will continue to outperform the US and Europe and also that the gap in valuation between US-listed Chinese stocks and their American peer will continue to narrow this year. But beware, not everything with a China-tag will behave like this, picking the right stocks will be crucial now more than ever.

I am making several adjustments to the China Portfolio this week:

China Recycling Energy (CREG): CLOSING POSITION: The stock has reached our target price of $4.50 and the position is now closed. The company will announce 2010 guidance with the annual report in March and without that guidance risks outweigh chances at current levels. I am SELLING 2000 CREG for Friday's close at $4.68 for a 65.37% gain or $3,700.00.

L&L Energy (LLEN): INITIAL POSITION: I was waiting for this stock to provide an entry point and now it looks like the $6 level will hold. L&L is a Chinese coal-mining and coal-washing company that also runs a wholesale distribution network. L&L is growing extremely fast in all these business areas. Last August the company guided for fully-diluted 2010e EPS of $0.94 and year-over-year net income growth of 183.8%. At current levels this translates into a P/E of just 6.5 and with this projected growth rate I won't even get into a P/E/G ratio.

But it doesn't stop just here. This month alone L&L Energy announced two acquisitions which should provide upside to the August guidance. The company added additional coal washing capacities and also another operating coal mine. And another major catalyst for the stock price is expected in the next three months: uplisting to a national exchange (NYSE/Amex or Nasdaq). I am ADDING a FULL POSITION of 1500 LLEN for Friday's close at $6.15 to the China Portfolio. My price target for the stock is $13.00 based on 12x expected EPS of $1.08. I consider this target to be very conservative with likely upside later in the year.

Currently there are several other potential additions to the China Portfolio where I am looking for an entry point. Those stocks include RINO, YONG, LPIH, UTA and NEP. As I can only make adjustments to the portfolio at Friday's close you might want to consider those five stocks during the week if a good opportunity to start a position comes up.

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