Why It's Not Too Late to Short China

Standing in front of the meat case this morning, it hit me like a ton of bricks. It wasn't an epiphany exactly, more like the feeling you get when the cleat of reality kicks you where it counts.

"It can't be," I thought to myself as I ransacked the case, checking out the price of every piece of ground beef that I could find.

But it was true. At the Giant this morning, ground beef was selling for $4.89 a pound. And it wasn't the high-end stuff either, it was 80/20. It totally blew me away.

$4.89 for ground beef? You have got to be kidding me. People can't afford that.

But as bitter as I was at the thought of a $12 meatloaf, it occurred to me that my resentment was probably nothing compared to what Chinese consumers are going through these days.

And it reminded why it is definitely not too late to go short China--even with Ben Bernanke throwing money out of the helicopter as fast as he can.

The Short China Story

You see, while the rising prices that we have seen here lately are pretty painful, they are really nothing compared to the inflation rate in China. For Chinese consumers, it is more than twice as bad, clocking in at 8.7% year over year according to data released on Tuesday.

That was the highest inflation reading in China in over eleven years.

And as with us, it is in the grocery store that the Chinese have been really robbed. Food makes up a full third of Chinese consumer spending. Grocery store prices there rose 23.3% last year, according to the National Statistics Bureau, led by a whopping 58% increase in the price of pork alone.

In fact, rising food prices have become such a problem in China that the communist government is now actively doing everything it can to keep them down in hopes of heading off a serious political backlash. That includes numerous interest-rate increases and price controls.

But it's not just the weakened state of consumers here and in China that leads me to believe the Chinese market bubble is about to collapse. The technicals also show me it is not too late to short China.

The Chinese Death Cross

Here's why.

It's known to technicians everywhere as a death cross, and it is happening on the Shanghai Composite Index. That's the index that has jumped by over 450% during the last two years--a sure sign of a speculative bubble.

A death cross is formed when the 50-day moving average of a stock falls below (crosses) the 200-day moving average. It indicates that there are currently more people selling than buying the stock. It is as bearish as it gets.

And it's not the first time the exchange has seen the "death cross," either.

Take a look:

As you can see, the death cross came twice on the index over the last five years, first in 2003 and later in 2004. Each time, of course, the index dropped dramatically, culminating in a 50% decline over all.

And while a third death cross hasn't actually completed yet, the Shanghai Composite continues to drop even as a Bernanke-inspired rally pushes the Dow higher. The index actually lost nearly 3% on the same day the Dow rallied 440 points.

So is it too late to short China by going long the UltraShort FTSE/Xinhua China 25 Proshare ETF (AMEX: FXP)?

Not at all, when you consider how rising prices worldwide will slow down consumer spending here and abroad.

And if you need proof, just make yourself a meatloaf. But also remember what it must be like to make one in China.

High inflation kills growth every time.

Comments

[submarino]

Despite the 30% selloff, A-share valuations
remain expensive at 32x historical P/E and 5.9x P/BV.
Consensus’ 25% 2008-09 EPS growth expectation is
unrealistic amid global stagflation risks.
What is worse, A shares still trade at roughly a 70% premium to
H shares, which implies further downside for large-cap
financial and property stocks in both markets.
Considering domestic inflationary pressure and the rate
environment, until A shares come down to trade at
around 20x P/E, the market might not find too much
support.

[abcde_98]

Similar to a control over supply, and demand for whatever reason not recognizing it. Example company ZYX lets 10% of its stock for sale i a hit market. Everyone want the shares and bids the price up 25%, 50%, 150%. Just ridiculous, only because of manual repressing of supply

[JXie]

Yes A-shares are expensive, and SSECI technically may have a way to go at the downside. But you aren't shorting SSECI with FXP. You are essentially shorting the 25 H-share stocks. They track a lot closer to HSI than SSECI.

[Mr. Zhao]

Downside is rather limited now since A shares historically carry a 50%+ premium over H shares. IOM H shares are already rather cheap and have bottomed. Your shorting of H shares with FXP is dangerous to the health of your portfolio.

China's inflation is the result of excess liquidity from a variety of complex factors but I do see the problem easing a bit going forward. I have great confidence in China's growth.