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by John Nyaradi

By now, you are probably quite familiar with the roller coaster known as China's economy. Most Americans find it quite hard to see 7.75 percent annual economic expansion as a bad thing. However, in China it is nearly cause for panic.

Although the International Monetary Fund had previously forecast 8.0 percent GDP expansion for China in 2013 (in the IMF's World Economic Outlook, published in April), the forecast was revised to only 7.75 percent expansion during 2013 and again in 2014 at a May 29 press conference. Here is what David Lipton, First Deputy Managing Director of the IMF had to say about China's economic growth at the press conference:

"While good progress has been made with external rebalancing, growth has become more dependent, perhaps too dependent, on the continued expansion of investment, much of it in the property sector and much of it involving local governments whose financial position is being affected as a result. High income inequality and environment problems are further signs that the current growth model needs to adapt."

As we have seen, China's real estate bubble has continued to cause problems for the financial sector. In a zealous attempt to rein-in the nation's reckless shadow banking system, notorious for shoddy lending practices, the People's Bank of China (PBOC) nearly caused an international liquidity crisis which threatened the world's emerging markets.

By June 20, the situation in China was becoming chaotic. Both the Shanghai Composite Index (NYSEARCA:FXI) and Hong Kong's Hang Seng Index NYSEARCA:EWH) fell nearly 3 percent after the nation's interbank offered rate rose 5.78 percent to 13.4 percent, causing severe liquidity problems.

More bad news came in the form of the HSBC Flash China Manufacturing PMI report for June, which dropped to a nine-month low of 48.3 from June's 49.2. The Flash China Manufacturing Output Index fell into contraction, with a reading of 48.8 compared with May's 50.7 for an eight-month low.

The PBOC had taken a firm stand against any manner of loosening its monetary policy to rescue the nation's banks. As a result, China's financial sector continued to twist in the wind, scaring the hell out of investors, worldwide.

By June 21, rumors began to circulate that the People's Bank of China provided some overdue liquidity injections to major banks which had been unfairly impacted by the PBOC's credit squeeze. Nevertheless, on Monday, June 24, the PBOC was posturing itself as the uncompromising bully, telling the banks to clean up their own mess.

June 25 brought an about-face by the PBOC. After announcing that it would loosen its monetary policy to resolve the liquidity squeeze which escalated interbank lending rates in the nation, the PBOC also admitted that it did indeed provide liquidity injections to some of the nation's major banks during the previous week.

On June 26, financial stocks led a retreat on the Shanghai Stock Exchange, due to questions as to whether smaller banks would benefit from the PBOC's new plans. The PBOC had already intervened to assist the major banks during the previous week, but what accommodation (if any) would the PBOC extend to the nation's smaller banks?

During the June 27 trading session in Shanghai, the financial sector led an early stock market advance after the PBOC continued to relax its liquidity squeeze, allowing interbank lending rates to resume their decline. Nevertheless, many analysts voiced expectations that liquidity would remain tight in China for at least two weeks, as the dust continues to settle.

By Friday, June 28, the financial sector led the advance in both Shanghai and Hong Kong after PBOC chief chief Zhou Xiaochuan announced that the central bank would provide guidelines on reasonable lending practices and foster lending growth while adjusting market liquidity in a manner it may deem appropriate.

Investors who would like to benefit from the volatility in the Chinese stock market – either by playing the long side or the short side – should consider one or more of the following ETFs:

iShares FTSE China 25 Index Fund ETF (FXI): This ETF is designed to track the FTSE China 25 Index Fund. The FTSE China 25 Index tracks the performance of the top 25 Chinese companies; each company is traded publicly on the Hong Kong Stock Exchange.

china, fxi, nysearca:fxi
iShares MSCI Hong Kong Index Fund ETF (EWH): This ETF is designed to track the performance of the obtain results which correspond generally to the price and yield performance of the MSCI Hong Kong Index. The fund will, at all times, invest at least 80% of its assets in the securities of the MSCI Hong Kong Index.
SPDR S&P China ETF (GXC): This ETF seeks to closely match the returns and characteristics of the total return performance of the S&P China BMI Index.

iShares MSCI China Index Fund ETF (MCHI): This ETF is designed to obtain results which correspond generally to the price and yield performance of the MSCI China Index. The fund will at all times invest at least 90% of its assets in the securities of the MSCI China Index.

Guggenheim China Real Estate ETF (TAO): This ETF is designed to obtain results which correspond generally to the price and yield performance of the AlphaShares China Real Estate Index. The fund normally invests at least 90% of total assets in common stock, ADRs, ADSs, GDRs and IDRs that comprise the AlphaShares China Real Estate Index.

ProShares UltraShort FTSE China 25 (FXP): This ETF is designed to obtain results which correspond to two times the inverse (-2x) of the daily performance of the FTSE China 25 Index. The fund invests in derivatives which ProShares Advisors expect to have similar daily return characteristics as two times the inverse (-2x) of the daily return of the index. The index is comprised of 25 of the largest and most liquid Chinese stocks listed on the Hong Kong Stock Exchange.

china, fxp, nysearca:fxp
Bottom line: China has serious short term and long term problems. Short term is the liquidity crisis and the country's slowing economic growth. Long term is the aging population. By 2030 China will have more people over 65 than the U.S. has people. All of this creates opportunities for ETF investors who can take advantage of the chaos in China.

Disclosure: Wall Street Sector Selector actively trades a wide range of exchange traded funds and positions can change at any time.

Source: Trading The Chaos In China