'Second Half Recovery' Thesis Alive and Well in China

In case you haven't noticed from my recent posts, fundamentals mean zilch and program traders/quant computers are using technicals for everything. The #1 reason for buying everything nowadays is "well the charts say so" aka "when bad news is announced stocks go up, and charts improve! I'm a buyer!"

We mentioned this weekend China looked poised for a breakout [China is Just About Poised to Break Out] - and it continues its run; in fact it's looking like the best subsector out there right now based on chart alone.

I honestly believe, fundamentally there are some serious issues to come in 2009 for China but as I've stated I do believe the world will lead us out in the future recovery, not the US. China will be a leader but I think they have some rocky road first. To whit -

• China's exports and imports shrank unexpectedly in November as the world's fourth-largest economy slowed in a startlingly abrupt way in response to the global credit crunch.
• The drop in exports from year-ago levels was the largest since April 1999, while the decline in imports was the steepest since monthly records kept by bankers began in 1993.
• Economists had expected China's exports to rise 15 percent and imports to be up 12 percent compared with November 2007. But the data showed exports fell 2.2 percent from a year earlier and imports dropped by 17.9 percent.
• A plunge in the price of oil and other commodities cut China's import bill, but economists said the drop also reflected spreading weakness in home-grown demand as businesses and consumers battened down the hatches.
• "It's just a start. Exports and imports will continue to fall in the coming months, probably until next June," said Zhang Shiyuan, an analyst with Southwest Securities in Beijing. (aha, the 2nd half 2009 recovery lives in china as well - at least there I can give it some credence)
• The government has been unusually frank in acknowledging its worries that the economic downturn will cause unemployment to soar, jeopardising social stability.
• "The situation is quite severe. We are slipping into a deflationary recession risk pretty fast," said Isaac Meng, an economist with BNP Paribas in Beijing.

If you read those statistics and comments and I took out the word China, would it really read any different than what is happening anywhere else? I'd actually be even more concerned about the drop in imports rather than exports because the Chinese thesis right now is the domestic-led economy will offset the loss of the export economy (which is reliant on American soccer moms re-mortgaging their house like its 2005). Perhaps the 70% drop in their market already discounted that - we'll see - the sexy word of the past two weeks is "it's all priced in". Famous last words as we've seen in 2008. (note: I'm very bullish long term on China)

As for the US, I'd say what people "think" is going to happen to the economy is priced in, but these folks are all of "2nd half 2009 recovery" and "government is our savior" mindset. If you believe that, then yes you should be blissfully buying stocks while drinking prodigious amounts of Kool Aid as neighbors lose jobs and houses (all of which will of course end on June 30th, 2009). If you are new(er) to the blog, I was writing these exact same comments last winter and spring as pundits from left and right told us to expect the "2nd half 2008 recovery"... one of these years they are going to "nail" this call and tell us "see, I told you!"

Now I am looking at 3 other sectors and beginning to rebuy some hedges on the short side since we have almost nothing (4% exposure) on that side (we've just been building up cash). These are easy technical trades - the ETFs on the long side are all approaching a key resistance area - if they break through, then you have to "cover" your shorts (or effectively sell the Ultrashort ETF). Since we cannot short an ETF/equity the parallel to that is buying the Ultrashort. These are the 3 I am looking at.... commercial real estate, financial, and emerging markets (of course China is part of the latter but a subset) - I posted shorter term charts of the financial, commercial earlier today.

Obviously in our "student body left" trading environment, you cannot look at these in isolation, because if the indexes continue to move up they will most likely take everything along with them, and vice versa. But my strategy for now, being so lacking in insurance (short exposure), is to begin rebuilding the Ultrashorts against these 3, and then if their inverse (Ultra) breaks through to the upside - scale back and let the animal spirits continue this run upward. Of the 3, I'd be most nervous about Emerging Markets because I actually like that sector over the long haul as opposed to the other two. But that's talking fundamentals, which we don't bother with anymore since it is all technical trading and sentiment.

As has been the rule for much of 2008 it is not what you own, but your allocations between "long", "short" and "cash". I expect more of this in 2009 as an investing market has seemingly died this year and has been replaced by a trading market.

After such a large move up in a short period of time, a healthy action would be a retrace to S&P 870 or 840, some consolidation sideways, and then a new leg up for a final Santa Claus rally. Don't you think these hedge funds want to "mark the books" the last few days of the 2008? We'll see how it goes.... but again our thesis is a period of Obama love reigns, then reality follows. Pundits talking how this was the worst quarter, and Q1 2009 will stink but then everything improves. Until it doesn't (materially). 2nd half 2009 recovery dreams... until 1st half 2010 recovery becomes the fashionable call. etc

Perception is reality. Fundamentals will worsen beyond what the pundits now believe - hope is everything. Hope is not a long term investing thesis... (but one can trade hope for a few days or weeks)

Comments

[Alan Young:]

Good article. I keep nodding in agreement with your central idea.

But to be practical...

I don't think we can predict how Chinese equities will perform. Even in a slowing economy, they are the best game in town, and the country's cash reserves are a potentially powerful weapon. So I wouldn't bet against emerging markets now.

Shorting financials, yes; plenty of shoes left to drop.

Shorting commercial REITs-- how do you do this? SRS pits you against the whole universe of REITs, including industrial, healthcare, and even timberlands, which could hold the index at support, or at least slow its decline. Besides, REITs pay huge dividends, so this gets really expensive if you are early.
If you can't do it by ETF, you have to find individual stocks to short, which is a lot more heavy lifting.

2008 Dec 11 02:39 AM

[Ames Tiedeman:]

China will get through its problems. They will still grow 5-7%.

2008 Dec 13 05:51 PM

[CLH:]

People get use to doing one thing and dont notice things have changed. I see very little downside risk and a lot of upside. Trading will not work. Select your stocks and hold on.

I guess the final straw for the bear was Fri. when the auto bailout looked like it would crash the market (as the auto companies wanted). However, there was almost no selling. I beleive there are few left to sell which means the market is headed up--both US and China.

2008 Dec 14 09:50 PM

[BxCapricorn:]

I think the selling stopped because someone was placed in an ankle bracelet. Enter reality.

2008 Dec 17 09:52 PM