Is Now the Time for Chinese Stocks?

Includes: CNY, CYB, DIA, QQQ, SPY
by: Jim Trippon

At last! China investors have finally been rewarded for their patience. After a tough first half of the year, I was beginning to wonder when this day would come.

In Shanghai, stocks rang up their biggest weekly gain of the year. The Shanghai Composite Index jumped by more than 6% for a number of key reasons.

In short, we saw a lot of indicators that China's economy is in great shape for the rest of the year. Even better, key companies are expected to turn in solid second half profit gains!

First turning point: China's big banks showed better NPL ratios. We've all heard worries that Chinese banks would be saddled with big non-performing loan burdens because of a real estate bubble. Not so. The bad loan ratio at Chinese banks fell to 1.30% at the end of June. China's top banking regulator says the ratio is down from 1.58% at the start of this year. That means China won't face a replay of the U.S. banking implosion.

Chinese banks have more than enough money set aside to cover bad loans. The banks have made provisions to cover 186% of non-performing loans – a comfortable safety margin.

Second turning point: I see rising confidence in banks is a tide that lifts all boats. Shares of China's major banks rose in tandem at the end of the week. That helped push the Shanghai Composite to its record rebound.

Agricultural Bank of China led the charge. AgBank gained 2.9% on news that Morgan Stanley (NYSE:MS) had boosted its stake in the bank's Hong Kong-listed shares. In a major show of confidence, Morgan Stanley's holdings have risen to more than 16% of AgBank's Hong Kong listing.

Third Turning Point: China's leaders pledged again to maintain a "modestly loose" monetary policy. That means no sharp slowdown in bank lending. Aggressive lending has worked like a hit of caffeine on the Chinese economy.

U.S. Investors Share the Gains

I often see Chinese stocks and American ADRs moving in different directions. Not this week. The Bank of New York Mellon China ADR Index is also up 6%.

The Big Bounce in China Stocks! More to Come?

Courtesy: Google Finance

What a great week for Chinese stocks traded in the U.S.!

But China investors have a ways to go to make up lost ground. Fortunately, there are good indicators on that front.

Fourth Turning Point: China's economic growth eased slightly in the second quarter to 10.3%. As I said recently, a mild economic slowdown would come as a relief. The 11.9% growth rate during the first quarter was just too fast to be sustainable.

For the rest of the year, I'm expecting a "just right" growth rate of about nine percent.

Fifth Turning Point: Inflation appears to have peaked. With inflation now at 2.9%, the danger of overheating is fading. When inflation was running at 3.3% and rising there was a real danger of a boost in interest rates to cool down the economy.

There are a number of other macro measures that Beijing is using to boost growth within China as the U.S. and European export markets continue to falter.

Stock Bounce Predicted

Investors may be wondering when stock markets will reflect all the encouraging news. After all, economic indicators have been strong all year. But markets, especially the Shanghai Exchange have been a big disappointment.

SSE Composite Index (Year-to-date)

The Big Bounce in China Stocks! More to Come?

Courtesy: Google Finance

Reports are now starting to pour in from brokerages around the globe that Chinese stocks are poised for a bull run. Technical analysts at JP Morgan say there are signs that the bull cycle which began back in 2008 be revived. Of course, that bull run was cut short by a U.S. financial panic that spread around the world.

According to a Bloomberg report, this week's stock rally, with three consecutive sessions closing above 2500, is a positive signal. A closing above 2650 would be a "very bullish" indicator that stocks are headed for a 21% gain.

Inside China there's more optimism. Shenyin & Wanguo Securities says Chinese equities could jump by 17% in the second of this year. BNP Paribas, Morgan Stanley and AMP Capital have also come out with bullish assessments of Chinese equity markets.

In Japan, Nomura says Asian equities may "surprise on the upside" in the second half because the global economy is likely to avoid a recession.

In short, we're getting the thumbs up from analysts on both sides. Technical analysts say that the conditions are right for a rebound based on an exotic tool called Fibonacci analysis.

And, if you don't believe in technical indicators, the fundamentals are also good.

In my next blog I'll take a look at why good fundamentals are just beginning to bite in. And, in my next "Word To The Wise" I'll look at the prospects of positive Chinese market movement for your global portfolio.

Disclosure: No positions