Banking Sector FY2008 – Positive for Japan and India, Negative for China

February 8, 2007– Occasionally, I’ll revisit prior blog entries and provide a very quick update. Several months ago, I said that I would avoid buying stocks of Chinese banks. Despite the recent comments of a top Chinese politician that the Chinese stock market was manifesting the signs of a “bubble” ready to burst, China’s economic growth appears to be more sustainable for now in comparison to India. My comment about avoiding Chinese bank stocks despite the great fanfare their IPOs were receiving in the global financial media was simply due to the fact that the sacrifice of strict risk management controls in pursuit of profits and spiraling growth makes a fine recipe for future disaster.

However, risk management controls for many of India’s banks are far more developed. HDFC (NYSE: HDB) and Icici bank (NYSE: IBN) were two such banks I mentioned in a prior blog. At that time, I mentioned that both HDB and IBN had run up in price much too quickly so a pullback in price was necessary for one to have a decent risk-reward scenario for either of these stocks though I favored HDB over IBN. Last week, we saw such a significant pullback in both stocks although both recovered somewhat by the end of the week. However, even with the significant dip in price, I would still approach HDB from the strategy of not rushing in at once, and instead with caution.In Japan, as the economy continues to recover, I also believe that bank stocks will provide some rewards this year as financial stocks typically outperform in countries with recovering economies. Ironically, Japan’s prolonged economic recession over the past couple of decades was triggered by exactly the conditions present in China’s financial sector today — poor risk management and greed spurred by the pursuit of rapid growth and profits. Decades ago, when many Japanese banks made huge bets with high-risk, high interest rate loans that turned sour, they tried to recover from this bad bet by making even higher-risk, higher-interest rate loans to cover for the increasing bad debt in their portfolios.

Of course, this just triggered a downward spiral that eventually necessitated the intervention of the Bank of Japan to prevent a collapse of the Japanese banking industry. Today, we would hope that Japanese banks learned a great deal of “what not to do” from their poor risk management controls that caused a two-decade long recession. In fact, many Japanese banks today stress tight risk-management controls in their marketing materials. While the recent mergers at the top of the Japanese banking sector have produced some banking giants that will provide the more conservative plays, mid-sized Japanese banks, rather than the giants, will probably provide the greatest upside during the continuing future recovery period.

In the end, remember that there are always good stocks in bad sectors and bad stocks in good sectors and that individual stock selection is the key to building wealth.

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J.S. Kim is the founder and Managing Director of maalamalama, a comprehensive online investment course that uses novel, proprietary advanced wealth planning techniques and the long tail of investing to identify low-risk, high-reward investment opportunities that seek to yield 25% or greater annual returns.


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