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Is China a leading indicator?
China’s stock market started rebounding in November 2008, about four months before most other global markets which only started their rallies around March 09. I have been watching the Shanghai Composite Index (ticker symbol ^SSEC on Yahoo Finance) which has rallied about 100% since Nov 2008 and seems to have peeked around early August 2009. The index has since fallen 20% since August 4, 2009. Is the rally simply taking a pause, and will resume its upward climb soon? Or is it the end of the rally and the index is headed back to test the lows of 2008?
From a fundamental perspective, we all know that the recovery has been a result of the Chinese government’s huge stimulus package. The government has encouraged their banks to increase lending in an effort to prevent a recession. If you believe that the stimulus has helped to start a real long term recovery, then you will probably believe that this is just a correction or simple profit taking and the rally should resume as the economy recovers. However, if you think this easy credit has simply helped to create a bubble (not unlike the US housing bubble which started in 2001), then this 20% correction could be the start of the bursting of that bubble. I found this interesting article China Has Become a Giant Ponzi Scheme, written by Andy Xie, a former market analyst for Morgan Stanley in Asia on the Big Picture blog, one of the financial blogs I subscribe to.
From a technical analysis perspective, it also does not look good as prices have broken below the uptrend line which has been in place for the last eight months. From the above chart, China’s stock market tend to have very clear trends – either they go up or down and there is little sideways action, unlike more mature markets like the US. Personally, I also think this is because the markets there are relatively unsophisticated. You can only buy and sell stocks. There is no short selling or derivatives like options, CFDs, etc that you can use to hedge your stock positions so if there is a loss in confidence in the stock market, the only way to prevent loss is to sell your stock which could cause the market to fall very quickly if everyone is trying to sell at the same time. For a more detailed technical analysis, see Drop in China Stocks Bode Poorly for Broad Market for a well written analysis from the Barrons Online website.
From my own analysis, I think the Shanghai market is headed for a fall (this is just my personal view and should not be taken as a trade recommendation) so I decided to buy some shares in a leveraged inverse ETF called FXP which should go up if Chinese stocks fall. For more information about inverse and leveraged ETFs, please read my earlier blog post How your SMSF can profit when the market goes down. Of course, I could be completely wrong about market direction or FXP may not mirror the Shanghai Index as closely as I hope so I have also bought put options to limit my loss to less than 8%, if the trade does not work out for any reason. Below is the risk graph of my trade which has unlimited upside potential and a limited risk of USD 850.
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Hi Christina,
Great blog!!!
Will be following with interest
Hi Mazzatelli
Thanks and thank you for posting a comment. We are a new blog so it is nice to get feedback to know how we are doing.
Christina
I don’t know your timeframe but long FXP + put = FXP call
Could save you margin and commissions
Quite true. My timeframe is at least few months as last down leg lasted 12 months. Options are pretty expensive as IV is about 85% so I decided to buy FXP and a Sept09 put option just to limit initial downside risk. If the trade works, my plan is to roll up my put to lock in unrealised gains.
Sounds good!!! Best of luck!!!
Vol does seem high relatove to past. Although the put benefits from vol skew, decline in vol-line outweigh and hurt.
Have you considered being long spot with stop loss. Once partial gains are realised to convert to synthetic call? The effect will be legging into call for a credit or very small debit [close to risk free].
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[...] RSS feed. Thanks for visiting!I have been tracking the Shanghai Composite Index on this blog since August 2009, when it made a sharp 20% correction. When I last looked at the Shanghai Composite Index on [...]