Shanghai Composite: What Does Today's Reversal Mean?

Jan.24.13 | About: iShares China (FXI)

By Sean Geary

The Chinese market (NYSEARCA:FXI) has been on fire over the past few months, up over 17% since the beginning of December. However, over the past few trading sessions, the Shanghai Composite has stalled. What should traders make of this development?

Chinese markets outperformed towards the end of last year thanks to improving macroeconomic data pointing to signs of a sustained recovery in the Middle Kingdom.

The HSBC China Manufacturing PMI released Thursday morning in China initially pushed the Shanghai Composite higher. The index surged in morning trading to touch a six-month high on the back of the report. PMI came in at 51.9 for January, the highest reading in two years; these data indicate that the Chinese economic recovery remains on track.

However, positive economic performance is not necessarily positively correlated with aggregate stock market performance — look how the Sensex performed last year in spite of India’s (NASDAQ:INDY) macroeconomic woes.

While the Chinese economy is evidently returning to full strength, today’s performance in the Shanghai Composite could be indicative that a lot of this good news is already baked into the market.

Just as the Shanghai Composite hit a six-month high, stocks quickly reversed course, finishing the day down almost a percent, ending below the previous five sessions’ closes. Although some attributed this decline to North Korean threats, in light of recent exchange performance, it may appear to traders as if the red-hot exchange has found temporary resistance and could see a moderate pullback over the next few weeks.

As a result, and given the opaque nature of Mainland Chinese equities, jumping into the Shanghai Composite here is not recommended.

However, stocks with the right exposure to the Chinese consumer class are poised to perform well throughout 2013, barring a return of European woes that have at times hindered markets over the past few years or a further devolution of the political situation in the United States.