Reasons to Worry About China Stocks

This column was originally published on RealMoney on April 23 at 9:16 a.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

Have you noticed the breathless way in which people talk about China these days? In many ways, it reminds me of how folks used to talk about the Internet.

In the late 1990s, we kept hearing that the Internet was going to change everything. (It has.) We often heard about the massive "buildout" that was going to take place in the technology world. (It has.) And we always heard people on Wall Street make such comparisons as, "Yahoo!'s market cap is equal to the GDP of Finland, Sweden and Denmark," or something equally ridiculous to explain why Yahoo! was headed for the sky.

Well, you can imagine my reaction when I heard someone on CNBC note that China's GDP was equivalent to the GDP of three lesser countries. At least this time around, they're comparing apples to apples, but seriously, the last time I heard such comparisons was late 1999 with regard to Internet stocks.

Before that it was 1989, when we heard how the value of all the real estate in California was equivalent to the land under the Imperial Palace in Tokyo; the Tokyo market peaked the first week of January 1990.

This past week, we had a scare when the Shanghai market fell 4% on fears that China would hike interest rates. The next day, that market got right back on the bandwagon and regained its lost ground. This brought about songs of praise and talk of the Chinese market's resiliency.

Way back in 2001, when China first won the bid for the 2008 Olympics, I was living in Shanghai. I remember how thrilled and proud the Chinese were; there were fireworks displays and congratulations all over the place. I also knew, having lived in Asia for years already at that point, how much of a buildout China would need to get its infrastructure up to date for the Olympics. I was a China bull.

But people in America scoffed, mostly because the U.S. was in the middle of a bear market, still reeling from the fallout from the Internet buildout.

Here we are, six years later, and only about one year away from the Beijing Olympics, and everyone loves China. A few things come to mind here. First, whatever is needed for the Olympics has already been built, is in the process of being built, or is just about to be built. In other words, China is at the tail end, not the beginning, of its big buildout.

The Internet was going to change the world, and it has. China's appetite for raw materials was going to change the world, and it has. Aren't markets anticipatory? In other words, if the news is out already, where's the anticipation?

The next step is to take a look at the Shanghai Composite, the market that the whole world is supposedly watching. Below are two charts. The top chart is the Nasdaq Composite from June 1999 through March 2000. The bottom chart is the Shanghai Composite from June 2006 through the present.

Here's what the points on the charts represent:

• Point A on the charts is a roughly four-month sideways move.
• Point B is an initial surge upward. The Nasdaq rallied about 42% in that surge, and the Shanghai Composite rallied about 50% in that surge.
• Point C represents a two-month sideways move on both.
• Point D on the Nasdaq represents an approximate 18%-20% surge. So far, the Shanghai Composite has rallied 19% in its recent surge.

There's no telling how far the Shanghai Composite can rally on this particular run, especially because it gained 50% in the Point B surge, while the Nasdaq ran "only" 40%. However, to my eyes, these charts look eerily similar.

Let's look at some of the Chinese stocks that trade in the U.S. Not one of the charts shown below has made a higher high, and that includes the iShares FTSE/Xinhua China 25 (FXI), the ETF for Chinese stocks. Here's a look also at Ctrip (CTRP), China Life Insurance (LFC) and Baidu (BIDU).

I actually like PetroChina (PTR), in that I would like to see it cross that downtrend line. However, consider what U.S. oil, oil-service and refining stocks have done, and then look at this chart. Hey, I thought we liked oil so much because China's usage was growing exponentially?

I can't even remember the names of many hot stocks in 1999-2000 (probably because most have gone out of business), but I do remember Yahoo!, Amazon and, of course, Qualcomm. Please note on the charts below that all topped out and made their highs months before the market did in March.

Just because China didn't have any follow-through on the downside this past week it doesn't mean you should be complacent. There are too many similarities to Nasdaq in '99-'00 that tell me this market is vulnerable here.