Why you should buy China and quality financials

By Rupert Foster Aug 29, 2008

Rupert Foster

Each week, a professional investor tells MoneyWeek where he'd put his money now. This week: Rupert Foster, investment manager at Matrix Alternative Investment Management

The mantra in Asian investment circles for many years has been that the Chinese authorities would never allow anything to upset the stockmarket before the end of the Olympics. Well, the stockmarket fell 55% in the nine months before the games, then 10% over the first two days.

A contrarian might say that the end of the Olympics will be a buying opportunity. But the fundamentals do not support this. I certainly expect Asian stocks to rise in the long term, but for the next six to 12 months they will fall, allowing investors to buy up some very cheap, high-quality, multi-year growth stocks. So far in Asian markets, and in particular the two erstwhile darlings China and India, we have seen the unwinding of extravagant earnings multiples, but no real earnings downgrades either from companies or analysts. These will appear over the next six months, and will be felt hardest in the darlings.

Another mantra has been that China's authorities will be able to run their economy at a minimum 8% growth a year. With the collapse in exports from China this year and slowing domestic consumption (as shown best by the fall in air travel, rather than the official numbers), 8% GDP growth is close to impossible. An annualised rate of about 6% seems more likely by 2009's first quarter. The best ways to profit from this disappointment is through shorting the Hang Seng or any China-related index or exchange-traded fund (ETF). The damage will be felt most in Chinese banks, property and higher-end consumption names, such as Ports Design. These have so far looked defensive, but won't be as consumption really starts to slow fast.

The classic buy signal for Chinese and Indian markets would be magazine covers calling the end of the Chinese and Indian growth story. Yet there are still interesting opportunities across Asia. Many of these are in defensive areas where earnings upgrades will not be the story, but higher multiples will. Genuine defensive stories, such as China Yurun (HK:1068), will see their multiples grow to around 30 times as the rest of the market sees ongoing downgrades. China Yurun is China's leading slaughterhouse, meat distributor and branded meat manufacturer. It has just a 3% share of the slaughterhouse market, but has the best network of modern slaughterhouses and chilled logistics able to provide chilled meat to the burgeoning supermarket trade. This is a business that will grow steadily through rocky market conditions.

Elsewhere in the world I am looking at finance-related stocks with long-term quality franchises that have been sold down aggressively, including listed asset managers such as New Star Asset Management (LSE:NSAM) and Aberdeen Asset Management (LSE:ADN). They now trade at multiples of funds under management unseen for a decade or so. If earnings do not pick up, consolidation is likely to start here much earlier than in the banking sector. I would also add Cattles (LSE:CTT) to this list. The management team has gone through many cycles and its model is holding true this time – the newer players, the credit-card issuers and sub-prime mortgage players, will exit, leaving the way clear once again for the specialists.

Published in Tips & advice | More articles by Rupert Foster

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