Is the China Craze a Tech Bubble 2.0?

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Includes: EEM, FXI, INP, XLK
by: Richard Shaw

The recent near vertical rise of iShares FTSE/Xinhua China 25 Index (NYSEARCA:FXI), the China ETF which tracks the FTSE Xinhua 25 index, reminded us of the price rise of the technology sector (the Tech SPDR (NYSEARCA:XLK) and the NASDAQ Composite) just before the tech bubble burst a few years ago in 2000.

We explored that question graphically with the chart below, in which we superimposed two different time periods, 1999-2002 for XLK and NASDAQ Composite over 2006 for FXI. The similarity in the price action is striking. []


The red line is FXI in 2006. The green line is XLK in 1999-2002. The blue line is the NASDAQ Composite in 1999-2002
This overlay chart is hand traced over precise computer charts and is not as exact as a machine drawn chart, but is close enough for the points being made.

In each case, the "bubble" stock rose about 80% in 12-15 months. The XLK rose only 65% in a single year and took 15 months before reaching an 80% increase, while the FXI took only 12 months, a more rapid rise than XLK in the internet bubble period. Of course, there were specific tech companies that soared way beyond 80% before crashing.

The NASDAQ Composite, the official home of the internet bubble, had a price pattern similar to that of XLK.

Too much of a good thing is often a bad thing. It's true for candy, ice cream and turkey at Thanksgiving, and it is typically true for security price rate of change [ROC].

Here are precise comparative numbers:


Let's take a look at some technical measures for FXI:

There really isn't that much fundamental data to review about the portfolio of FXI, so we are left mostly to gauge macroeconomic trends and technical factors. The technical factors are not good, if you believe that very high ROC typically results in a reversal, and that reversals tend to continue until overdone.

For example, if FXI reverted to its 50-day simple moving average, it would decline a further 9%, and if it reverted to its 200-day average, it would decline a further 22%.

The 1-SD lower 20-day Bollinger band (a reasonable price swing target) is just above the 50-day moving average, 7% below the current market price of FXI.

We think the probability of more downside is greater than the probability of more upside in the short-term. However, anything, up or down, could happen with such a popular, hot money theme as China.

This doesn't mean that the China enthusiasm is based on thin fundamentals as was the internet bubble, but it does raise questions about the rate of change of China valuation and perhaps the level of valuation.

As the strong decline last week showed, there has either been a rethinking of valuation for emerging markets or profit taking deferred until after the last tax year.

The FXI gave a good head fake up before taking a dive down, as this five trading day chart shows. India (NYSEARCA:INP) and emerging markets generally (NYSEARCA:EEM) popped up a bit and took a dive also, but not as dramatically as China.

SPY EEM FXI INP

We are not calling a top or a crash, but we are nervous and wary of pattern similarities.

Our portfolio took a pretty good beating last week from the emerging markets. Last Friday we sold our positions in EEM and FXI (as well as a closed-end India fund) while we step back and re-evaluate

Disclosure: Authors owns none of the securities mentioned.