Trade War to Hit China-Focused ETFs

Sep.16.09 | About: ProShares UltraShort (FXP)

By Daniel Harrison

With all the turbulence in Chinese stocks in August, we’re seeing a big increase in the number of trading notes originating from Hong Kong that advise clients to seek protection in the ProShares UltraShort FTSE/Xinhua China 25 (NYSE: FXP).

The recent trade dispute between China and America hasn’t impacted Hong Kong share prices that much this week. But the impact on exchange-traded funds like FXP are likely to be felt during the fourth quarter.

Most of the attention of the trade dispute has been focused on the impacts the U.S. will likely experience from a lack of supply of cheap goods. But, if it becomes any more acute, investors in China are likely to fret that their income from exports won’t hold up as firmly as they did at the start of the year.

With the size of its massive stimulus this year, China badly needs income so that it doesn’t get left holding the bag one day. Analysts I've spoken with estimate that the Chinese government may be stimulating its economy by up to 30 percent right now in order to get an 8 percent return on gross domestic product growth.

FXP’s short focus is concentrated among financial firms and those which depend upon high levels of consumption to keep growing, such as China Mobile and China Life Insurance. Those are ideally placed short bets in the event of an escalating level of protectionism or a further round of monetary tightening.

FXP certainly isn’t for the faint-hearted investor. It’s worth considering that the ETF has dropped like a stone in the past year. After hitting a high of around $184 a share at the height of the Lehman Brothers debacle, on Friday last week it reached a low of $9 a share.

That depressed price has kept it treading the line of its net asset value lately. In the event of even a 4 percent sell-off in Asia overnight that leads to subsequent weakness in the U.S., FXP might easily spike back to its recent one-month high over $11 a share (see story here).

Be careful here, however, since there’s still a lot of optimism among institutional traders at the big banks. In that sense, it might make sense to dollar-cost-average into FXP buying on up days in the market. (While markets have shown a trend of rising at gradual levels recently, most of the selling has tended to come recently in big one- or two-day chunks.)

Perhaps the biggest risk FXP faces is that investors will tire of it when new margin constraints are put on it in December. But as my colleague Murray Coleman points out in a recent article, there’s less evidence to suggest investors are pulling out of leveraged or inverse ETFs right now than many media reports have led us to believe (you can read the story in full here).

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