China Stocks: 2011 Awful; 2012 No Clear Relief

Gene Linn  |

For China stocks, 2011 has stunk.

It didn't start that way. The Hang Seng Index in the gateway market of Hong Kong surged 6.0% to a year-high of 24,420 on January 18 and stayed strong early in the year. Even after a steep drop in the middle of the year, most analysts were confident the index would rebound to around 27,000 late in the year.

But in the end the Hang Seng tumbled 19.1% from the end of 2010 to last Friday’s 18,629. Investors now have to divine if the factors that pushed China stocks down will continue next year.

There are a number of culprits for the decline. The biggest is the worsening European debt crisis. The main damage to China stocks is the flight from risk launched by the crisis, including a sprint away from emerging markets. Prime evidence: In contrast to the Hang Seng, the Dow Jones Average gained 6.2% in 2011 through December 23. The U.S. dollar also was a safe haven, and a stronger greenback generally draws funds away from Hong Kong.

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American political gridlock and economic uncertainty also hurt. On the Chinese side, stubborn inflation weighed on stocks through the fall. Tight credit implemented to fight inflation contributed to falling economic growth late in the year.

On the plus side, Chinese inflation is falling substantially, which will probably allow Beijing to implement a series of cuts in interest rates and banks’ reserve ratios and to take measures to stimulate selected sectors of the economy. And the U.S. economy shows signs of growth, although uncertainty lingers.

But political gridlock is likely to get even worse in 2012 with the U.S. election coming, damaging investor and consumer confidence. Some analysts think the anemic markets in Shanghai and Shenzhen indicate the Chinese economy will continue to lose steam through the first half of next year.

And worst of all, going into 2012 there is no clear solution or end to European debt woes.

All in all it looks like the gloom will continue into the new year. However, Chinese corporate results generally have been strong in the midst of this year’s sharp stocks price drop and the Hang Seng’s paltry 5.3% gain in 2010. PEs are near historic lows, and valuations are enticing. If investors recover their appetite for risk in 2012, the bull market could run a long way. The Hong Kong market will reopen December 28.

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