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Should you Have Money in Chinese Stocks or ETFs?

Nov 21, 2012
Chad Karnes, CMT

China's economy is slowing, but the media has refused to recognize its long term downtrend. The time to buy is still not yet.

The Chinese stock market is down over 40% from its price highs in 2009.  Is it now finally time to put money into China and Emerging Market ETFs?

“All warfare is based on deception”, the Chinese philosopher Sun Tzu said in his ‘Art of War’.  This quote seems very appropriate given the experience I have had researching Chinese (NYSEARCA:FXI) and Emerging Market ETFs (NYSEARCA:EEM).

The Power of Google

This morning I did a simple Google (NASDAQGS:GOOG) news search for the past week on “China Economy”.  Out of 14 results, a surprising 12 were very positive in nature; one was neutral and only one was negative (and found near the bottom of the page).  One of those headlines is below & captures the overall sentiment.

“Six Reasons why China’s Economy has Bottomed Out and Two ETFs to Consider” –CNBC Marketwatch 11/8

It is perplexing to me to have such a resounding amount of positively skewed Chinese articles, especially given the reality of the situation.  On 8/17 in the ETF Profit Strategy Newsletter we noticed a similar media skew to the positive side of China’s growth which along with technical analysis alerted us of a high probability trade setup. 

The More Things Change the More they Stay the Same

On 8/17 with the Shanghai Composite Index (Shanghai:000001.SS) at 2,136, we alerted “China continues to be the media darling as their economy is still the world’s “fastest growing”, despite experiencing six consecutive quarters of slower growth.  Looking at a stock chart, one would never know China was in better shape than most of the other major countries in the world.  It has been in a bear market since 2009 and is down over 35% from that peak”.    

Below is the chart that was included in that update along with more commentary that “quite often fundamentals and economics have very little to do with actual stock price behavior.  There is no sign of letting up as price recently broke down from a 3 year low and now targets the 2008 lows”.

For a larger chart click here


China Today

Since August’s excessive media bullishness, the Shanghai Index has fallen another 6% now down to 2,000. 

If you had followed the media’s advice then you would be down significantly since August.  The attached chart shows just how bad that trade has been. 



Again today, the media continues to love China with virtually every news headline positive (NYSEARCA:GXC).  The media is still bullish after 3 months of continued price deterioration.

To add insult to injury, the lone negative google search article on China’s economy wasn’t even from the United States, it was from the United Kingdom!  “China’s economic destiny in doubt after leadership shock”, the British Guardian counter argues. 

Is the fact the lone negative review from Europe, relevant?  Who knows, but it certainly sheds some light on the group think and spin trap United States media companies can fall into. 

The uber-bullish media also helps support why the China long likely continues to be a bad trade.  For more on using contrarianism to support technical and fundamental analysis click here.

Your ETF has How Much China???

China’s performance may not interest you, but many of the more popular ETFs which aim to diversify your portfolio, contain a very large portion of Chinese stocks and thus have likely underperformed because of it. 

The third largest exchange traded product, the iShares Emerging Markets ETF (NYSEARCA:EEM) has 18% of its holdings from China.  This percentage skyrockets if you include all of the Asian exposure as the data below from iShares shows.  Brazil, Russia, and Mexico are the only non-Asia countries in the top 88% of the EEM index holdings.


China Tomorrow

Given the media’s still extremely skewed outlook on China and the technical analysis supporting the downside, it likely is too early to go long Chinese and Emerging Market ETPs such as the Direxion3x Levered Emerging Markets Bull  (NYSEARCA:EDC) or the Vanguard Emerging Market VIPERs (NYSEARCA:VWO). 

A breakdown of key short term support would also set up another high probability sell setup.  The 2,000 price level is very important and needs to hold or the 2008 low of 1700 is the next likely target.  Some short ETFs that can be used to take advantage of the extreme bullishness and technical setup of China when the time comes are the ProShares Short China (NYSEARCA:YXI) or the Direxion 3x levered ETP (NYSEARCA:YANG).

The ETF Profit Strategy Newsletter identifies important support/resistance levels and combines them with common sense technical analysis to provide a short, mid, and long-term forecast along with actionable buy/sell recommendations.

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