Chinese Shares Catch a Break

The selling in Asia eases, but don't bet on a bottom. Also, checking in at Lenovo.
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BEIJING -- Chinese equities saw a relief rally in Monday trading, and it was about time for a little green after a string of bruising sessions. The Hang Seng index closed up 0.4% to 15,964 and the Shanghai Composite index advanced 2.2% to 1649.

The past few weeks have been bruising for Asia investors, with Hong Kong-listed China shares surrendering 10.8% of their value between May 10 and May 22. In the same period, Asian equities (excluding Japan) lost over $420 billion in market capitalization.

Rally notwithstanding, no one's ready to call a bottom yet. Morgan Stanley China strategist Jerry Lou says he's sticking with a cautious view on the China market.

His take: Be wary of China sectors that have seen big year-to-date price run-ups and could be vulnerable to another emerging-markets liquidity squeeze, including properties, commodities and financials. His model portfolio is overweight in consumer staples, retail and the Internet. Among the names he likes are

Netease

(NTES:Nasdaq) and

Lenovo

(LNVGY:Nasdaq).

For some investors, the severity and speed of the selloff has eerie echoes of the '97-98 Asian financial crisis. But Citigroup economist Yiping Huang calls this latest crunch a "correction, not a meltdown."

Governments and banks alike have cut debt and strengthened their financial positions in the past nine years, he says. Case in point: Asian foreign exchange reserves, including Japan, rose more than threefold to $2 trillion between 1996 and 2005. The broad cushion of reserves limits the impact of any sudden withdrawal in equity investments.

Because equity markets still account for only a small percentage of household wealth, the recent volatility isn't expected to weigh on Asian consumer spending. The ratio of stock holdings to household wealth is only about 3% in China and likely stands below 15% in other emerging markets in the region, Huang estimates.

In fact, the worries that sparked the Asian selloff mostly concerned outside factors, such as uncertainty over the next Fed move and the potential for rising inflation and/or an economic slowdown in the U.S.

To be sure, regional investors have also gritted their teeth over the possibility of more policy tightening to slow down breakneck GDP growth in China. But Huang considers aggressive intervention unlikely, because it could lead to higher unemployment and increase bad loans at China's banks. Already in late April, Beijing raised interest rates, and regulators have recently been pressuring banks to slow the pace of loans to the booming real estate sector.

Meanwhile, this weekend brought another twist in a national security hubbub involving the U.S. State Department's purchase of computers from China-based Lenovo. On Saturday, one of China's best-known economic papers weighed in on the issue. Its complaint, in a nutshell: the U.S. government's actions have unfairly called into question Lenovo's independence and reputation.

Two weeks ago, a minor furor erupted on revelations that the State Department was buying 16,000 PCs from China's Lenovo, 9,000 of which would be used for classified work. U.S. politicos charged that the Chinese government, which owns a stake in Lenovo through one of its research arms, might covertly tinker with the PCs, then use them to siphon off state secrets. An embarrassed Foggy Bottom staged a quick retreat, saying it would be sure to use Lenovo computers only for non-classified work.

Now one of the hawkish China analysts who raised the alarm over Lenovo has tried to present his side of things to the Chinese press.

In a letter published over the weekend in the

Economic Observer

, a leading Chinese newspaper, Larry Wortzel, chairman of the U.S.-China Economic and Security Review Commission, said purchasing Lenovo PCs may "endanger U.S. national security," noting that a research arm of the Chinese government (the Chinese Academy of Sciences) owns 27% of Lenovo shares.

The response from the Chinese: a spirited defense of free trade.

In an editorial, the paper argued that Lenovo is a legitimate private company, not a government subsidiary, and there's no evidence that Lenovo's PCs would be used for espionage. The bottom line: PC sales shouldn't be subject to politicking.

It's an interesting countertake, because the Economic Observer is highly respected for its content and not a mere official mouthpiece. Its comments likely reflect the view not just in Beijing's corridors of power, but among China's own patriotic-minded citizenry (who are just as inclined to defend home-team players as Americans would be).

Expect more cross-border bickering along these lines in the future, as China's IT industry grows more sophisticated and expansion-minded. The country's most successful technology widgetmakers are increasingly bound to collide with foreign governments that are nervous about China's geopolitical ambitions.