IHS Chemical Week


Is China Set for Recovery? A stock Market Perspective


Mainland Chinese stocks have been on a rocket trajectory since bottoming last November.  Unlike the US markets, the Shanghai Composite (SSEC) did not make a lower bottom since then but a series of higher lows and higher highs.  From November’s “drop-dead” low at 1700, 72% off the 2007 peak at 6000, SSEC is up 50% and is in new Bull Market territory as of this writing, closing at 2529 on April 14 - more than 10% above its 200-day simple moving average, an important technical level, at 2202. Normally, the stock market is believed to anticipate economic recovery by around half a year.  From this perspective, it appears plausible that China has entered a recovery phase.  Optimistic data supporting this (source China Daily):


Industrial output expanded by a solid 8.3% in March

China’s exports for March were down 17%; as dour as that sounds, it was a significant improvement over February’s 25% drop (imports in March remained down 25%)

The Chinese PMI (Purchasing Managers’ Index) reached 52.4, over 50 for the first time since last July (indicating expansion)

Unlike the US, China has maintained healthy credit with new loans in Q1 09 at 93% of the level of last year’s Q1

As widely reported in the media, car sales rose to a record high of 1.1 million vehicles in March, exceeding sales in the US since January


Even allowing for some degree of statistical manipulation, comparing this to the data that is being touted as representing a potential turnaround in the US, one has to be struck by its persuasiveness.  Still, the Chinese economy is not out of the woods yet and it remains highly export-dependent (as much as 40% of GDP) though one must remember not only on the US consumer, and the rest of the developed world is, let’s be honest, not in as bad shape as the US.  There are though some prominent investors who think it is too early to be even in Chinese stocks, like Jim Rogers, Soros’ former partner, who foresees global inflationary pressures cutting off any prospect of rapid recovery (see www.chinadaily.com.cn/bizchina/2009-04/13/content_7671568.htm).


We are somewhat more bullish and believe the SSEC is positioned for another 50% gain to the 3750 area within a year to a year and a half, but in the intermediate timeframe (next 3-6 months) it is not necessarily a safe buy due to the potential impact of another downleg in the US.  Based on the daily charts (we don’t publish the charts we analyze on our website since they are copyrighted, but go to www.stockcharts.com for “$SSEC”) we see some risk of a pullback to the 200-day moving average.  There is also potentially strong overhead resistance around the 2700 level.  It’s worth remembering the foreign exchange effect: as it is virtually guaranteed the Renminbi will continue to appreciate against the dollar (albeit at a pace determined by China, not the wishes of the US), owning Chinese equities has favorable FX as a built-in hedge.  Rogers goes so far as to suggest that the dollar could come under speculative attack, which would further enhance the value of holding Chinese assets relative to US equities.


Unfortunately, there is no equivalent for the SSEC analogous to the US SPYders which track the S&P 500.  Hence, trading the “China market” entails selecting a fund or ETF (exchange-traded fund) that is an imperfect representation of the index.   Two popular ETFs are the iShares FTSE/Xinhua Index (FXI) and the MorganStanley China A-Share Fund (CAF).  The FXI has already made a 40% ascent off the March lows vs. only 22% for the SSEC.  We don’t really care for this kind of divergence from the index we want to track – FXI is very heavily weighted in financials (40% of the index) and oil & gas (18%).  CAF is even more overbought, up nearly 100% from Oct. lows.  If you are prepared to hold for the long term, it may make sense to ease in to positions over a six-month horizon, but remember either of these ETFs would definitely be vulnerable to an unexpected pullback in the SSEC, and, at least in the case of FXI, the Hang Seng.


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