Buy China on this dip - China Green Agriculture (CGA) and VanceInfo (VIT)

August 19, 2009 by Kenneth Reid

The next downside target for the S&P 500 is the 200-day ema around 950; for the Dow it is 8850. A test of that support would be totally normal. The major U.S. indices staged a technical breakout above the 200-day ema in July and breakouts almost always get tested. Hundreds of leadership stocks have gone through that testing process over the last month.

We suggest individual investors continue to look to buy dips in leadership names. Right now, many of the best performers are Chinese ADRs. In TSR Pro we have a 65% gain in China Green Agriculture (CGA) and plan to hold it through this correction. Why? CGA is showing evidence of institutional accumulation. When institutions start to pile into a stock for the first time, volume increases sharply. The volume spike in CGA is clearly visible on the charts.

The Shanghai market could be compared to the Nasdaq in the early 1990s. Shanghai is an immature marketplace populated with stocks from mostly unknown companies. IPOs, which were suspended last September, are now heavily promoted. This week Everbright Securities, the first Chinese brokerage to come public, jumped 42% on its first day of trading. Although Everbright is one of the smaller Chinese brokerages, the IPO was 116 times oversubscribed. China CNR, a manufacturer of railcars and rapid transit vehicles, is the next large company in line to raise capital with an IPO.

The seven companies that have gone public in China this year before Everbright surged over 100% on average on their first day of trading. Such volatility is the result of little financial infrastructure or hedging derivatives to mitigate price movement. Buying on margin and short-selling were introduced last fall for the first time ever.

In other words, things are just now getting started in the Chinese security industry. Don’t forget, China is not a democracy and the Chinese stock market is controlled by the government. It would clearly serve the Chinese government to have a strong Shanghai bourse, which would catalyze domestic consumption without draining the state coffers. The Shanghai bourse has already experienced a mini bubble and crash. We think the process will be repeated on ever larger scales over the next 5-10 years.

VanceInfo (VIT) is holding up fairly well during this correction. Shares are now trading 15% below its all-time peak and about 8% below the June high. This is not a severe pullback considering how far VIT ran from the March low. Around 27% of the float is held by institutions, which is contributing to stability, as institutions don’t panic on down drafts. They buy more. Oberweis, an outfit we respect, is one of the institutional holders.

Overnight the Shanghai index gave back another 4%, which brings it close to its 200-day exp. moving average. We think it will find support there.