China: Market Opportunity or Downside Catalyst?

Includes: EWH, EWS, EWY, FXI, GXC, THD
by: Jim Farrish
The chatter continues to rattle investors and money is heading toward the exits. For whatever reason (plug in one of the many), the sell now and ask questions later philosophy is building. Is this the end of the rally? Is the China issue the catalyst for a reversal? I am not advocating this activity, just observing the action and money flow over the last week. For those of you who follow technical analysis Nov. 9 was a reversal day. The chart below shows the reversal and what has transpired since then. Is this an exit signal for the broad markets? Time will tell.

As the chart above shows, we are early in the test of the trendline. Technically we broke below the trendline yesterday on the close. That is a negative, but the support at 1185 is just below and the line to watch short term. The reversal has resulted in a follow through on the downside. A look at the volume bars at the bottom of the chart show lower volume selling. That can be taken as a positive for support to hold at 1185. Again, be patient, watch and let this develop versus assuming.

There are plenty of discussion points we could address and pontificate on, but I am more interested in looking at what opportunities this may present, first from a trading perspective and second, from a longer- term investing perspective.

First, the trading perspective. China is the thorn on the rose currently. They are challenged with inflation near term heating up. The recent reports stated 4.5% and GDP growing near 9%. The objective is to slow growth enough to stem inflation. That brings with it the concern of stalling the economic growth. Thus, they have raised rates and rumor has it they have stopped lending for real estate development. Both are seen as a negative for the global economies. Thus, the short term opportunity being the downside move in China’s stock market continues, and shorting the country ETFs FXI or GXC would be the action to take.

If you don’t like the risk of the short play, wait for support to develop as the selling subsides and enter a long play for the bounce or recovery back to the upside. The choice will depend on your view fundamentally of the country's outlook for growth and ability to handle the inflation problem correctly. In other words, they will not over-correct the issues causing a further correction in stocks. The getting it just right side is a bigger challenge than it appears on the surface. A look at the Fed’s attempts in the U.S. markets over the last 20 years shows the potential pitfalls and resulting bubbles from manipulating the economic environment. Either way, there are opportunities building in reaction to China’s economic and inflation issues.

Second, the longer-term view of China is that it is on the right path to controlling the inflation issue and the pullback is an opportunity to add longer term positions to your portfolio. As above, you would wait for the pullback to run its course and then establish a position in the country based on the longer-term view of economic growth and global expansion. This requires patience in developing the position as well as the management of the position once it is established.

There are the ripple effects to consider equally as opportunities or instead of directly investing in China. We have previously invested in what I call the benefactor countries such as Singapore (NYSEARCA:EWS), Hong Kong (NYSEARCA:EWH), Thailand (NYSEARCA:THD) and South Korea (NYSEARCA:EWY). These are alternative to investments directly in China and the volatile issues facing its economy. I would watch to see how they progress in the current trading environment and then put in place a strategy for putting money to work.

There is plenty of speculation on the outcome of issues in China. It is important that we remember it is all speculation and not fact. Thus being patient and developing a strategy that fits your personality to take advantage of what the market presents is the goal. Discipline is the key to benefiting from opportunity.

Disclosure: No positions.