Consider Dropping Chinese ETFs: Latest GDP Numbers Look Suspicious

Includes: EWH, FXI, GXC
by: Options Markets

The latest GDP figures out of China show second quarter growth slowed to 7.5%, which is the 8th consecutive quarterly growth rate below 8%. At this stage, it looks as though the days of double-digit growth are now in the rear-view mirror, but when we look at some key factors in the region even rates of 7.5% start to look suspicious. It did not surprise markets to see weakness in the headline figures: A well-documented credit crunch and government limitations on bank lending requirements were seen in conjunction with weakening trade activity. This is the second straight quarter of declining GDP growth (gains of 7.7% were seen previously), and this negative question should send alarm signals for investors holding onto positions in the iShares FTSE/Xinhua China 25 Index Fund (NYSEARCA:FXI), the iShares MSCI Hong Kong Index Fund (NYSEARCA:EWH), and the SPDR S&P China ETF (NYSEARCA:GXC).

Overall declines in Chinese stocks have also been well-documents, with the Shanghai Composite Index falling more than 7% in a year when most markets are seeing recovery periods. Of primary concern is the fact that major reductions in aggregate financing were seen in conjunction with weakness in May/June export numbers and second quarter declines in manufacturing productivity. All of these factors in combination make it highly unlikely second quarter GDP in China truly rose by 7.5%. So, what exactly could account for potential distortions?

Contradictory Factors

One point of contention is that China releases its GDP data on a seasonal basis, which shows differences from the standard used by most countries (measurements on an annualized basis). If the Chinese data was calculated on an annualized basis, the report would have shown gains below 7%. Trade figures from April are another troublesome factor. Specifically, this report showed monthly export gains of 14.7%, which was dubious for two reasons. Exports that month to both Europe and the U.S. fell during the period. China was able to post export gains because of a 57% rise in exports to Hong Kong. But these date were met with skepticism because a pork worker strike in Hong Kong that month close many of the areas central trading ports.

All of this comes along with separate criticisms that the statistics released by the Chinese Finance ministers do not accurately adjust for inflation. Essentially, there are many troublesome factors involved -- and for those invested heavily in the country's benchmark stock indices, this sends a strong sell signal. The Chinese Finance Ministers continues to scale down its GDP projections for growth in 2013. Currently, these forecasts stand at 7.5% for the year, which implies that further declines are expected into the second half of the year. And, with all of the doubtful factors involved, it makes sense to consider selling the larger Chinese stock ETFs: EWH, GXC, and FXI.

Chart Perspective

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In EWH, prices have rallied since the GDP data were released, but this is a sell-able bounce as "support turned resistance" at 19.20 is likely to contain prices. The fund has already fallen through the 38.2% Fib retracement of its latest rally, so for short sellers the downside target rests at the 61.8% Fib retracement at 17.35.

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The series of lower highs in GXC is discouraging for the medium term prospects in the fund, and rallies into 69.80 can be viewed as good selling opportunities on a risk to reward basis. For these trades, a downside target should be exercised at 60.95, which is a level of historical support.

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A similar chart formation can be seen in FXI, but an alternative strategy is preferred here given its proximity to the lower end of its recent range. Instead, short sellers should wait for a break below support at 31.80 to initiate new short positions. This will suggest that historical support levels are no longer valid and that we will then be in for a series of lower lows going forward.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.