U.S. China Stocks Following Shanghai

Let's have a look at the leading indexes in the U.S. and China and what has happened so far this year:

The S&P 500 is currently down for 2010 by 1.12%. It started the year at 1115.10, printed the year's low on July 1 at 1010.91 and recovered since to 1102.66, a gain of 9.07% from the low of the year. For the week that just ended, the S&P 500 gained 3.55%.

The leading Chinese index, Shanghai Composite (SSE), started the year at 3277.14, dropped all the way to 2319.74 on July 2 and bounced back to 2572.03 on Friday. The SSE is still down a remarkable 21.51% for this year but has recovered by 10.88% from the July lows. For the past week the Shanghai index outperformed the S&P 500 with a weekly gain of 6.10%.

Last week was a significant one for the Shanghai market. The weekly rise was the biggest since December last year and the benchmark index climbed for five consecutive sessions to leave the year's low behind by almost 11%. Both the U.S. and Chinese market reached their lows at the same time, however Shanghai has clearly outperformed the S&P 500 for the week and for the third quarter. Still, while the U.S. markets are now almost flat for the year, the Shanghai Composite is still more than 20% lower at this point.

Many analysts regard the drop in Chinese share prices as a buying opportunity now. BNP Paribas, Nomura and Morgan Stanley are expecting a rally for the Chinese market with Morgan Stanley analyst Jerry Lou predicting the Shanghai Composite might climb to 4,000 by June 2011. That would be a 55% gain from current levels.

I am tracking the performance of U.S.-listed China stocks with the Trading China Main Index (TCM). This index holds the 40 largest China-based stocks on senior U.S exchanges (Nyse, Nasdaq, Amex) with a market capitalization below $1 billion and positive net income. The TCM is currently at 880.51, down 11.95% for the year, and reached its low on July 6 at 772.04. Due to a market holiday on July 5 and the preceding weekend, July 6 was the trading day right after the Shanghai Composite marked its year low.

Since July 6 the Trading China Main Index has gained 14.05%, and for the last week alone it climbed by 9.16%, clearly outperforming both S$P 500 and Shanghai Composite. A weekly gain of more than 9% for U.S.-listed China stocks is significant, we haven't seen such a performance in a long time. Many of the better-known names on the index are up 15-25% for July: L&L Energy (LLEN) 25.11%, VisionChina Media (VISN) 23.00%, China MediaExpress (CCME) 22.00%, Yongye International (YONG) 19.30%, A-Power Energy (APWR) 17.83%. However, those gains could be just the start of something big as most stocks are still down heavy for the year. Leading wind energy play A-Power started the year at $18.29 and despite the 17.83% gain for July the stock is still available at a 54.13% discount - or in other words, it would have to double from here just to reach the level of December.

I believe there is a good chance that we have seen the worst levels of the year, both for the Shanghai Composite and for U.S.-listed China stocks. Even if you don't believe in Morgan Stanley's ambitious 55% gain for the broader Chinese market within one year, it seems quite likely that China will outperform the U.S. markets from here on. And if that happens, if the current trend is confirmed over the next few weeks, then we should see significant gains in quality Nyse/Nasdaq-listed Chinese stocks for the remaining five months of 2010.