China Stocks: Risks Ahead

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Includes: FXI, FXP
by: Yogi Shankar

In my current line of work, I travel a lot to key international markets (China, India, Brazil, Europe) and interact with a wide range of business people. I am also an active trader of my portfolio.

It is shocking to me as to how companies in mainland China have a complete lack of transparency as it pertains to their financials. It is very difficult to figure out the extent of government involvement and amount of government financing in these enterprises. It is also very tough to figure out true profitability due to substantial subsidies that many of the enterprises get from the Chinese government.

As such, I am amazed at the talking heads in CNBC and many of the wall street analysts who continue to recommend investing in iShares FTSE/Xinhua China 25 ETF (NYSEARCA:FXI). In my humble opinion, with inflation spiking (inflation soared to a near 12-year high of 8.7 percent in February), mainland Central Bank is bound to increase interest rates substantially this year (China last year increased its key rates six times and in January raised the reserve requirement on bank deposits to its highest level since the 1980s). This will be a major deterrent to stock prices going higher.

Another key fact to note is that monies have been flowing to the stock market in huge quantities because real estate prices have gone up 5x and 10x in many markets. Ordinary citizens who cannot afford to chase the real estate market are instead putting money into the stock market. This real estate bubble is bound to collapse at some point. With interest rates going up, and home prices slowly coming down, this is a recipe for disaster for the stock market. The government due to the Olympics, etc, will of course not allow a complete stock market meltdown to occur, but there is a good chance of an additional 5% - 10% correction this year.

Therefore, I feel that even though FXI has come down from a high of $219 to a low of $128, there is still significant downside. One effective way of playing this downtrend is buying the Ultrashort of FXI (NYSEARCA:FXP). I have made good money trading FXP (including last week). Plan to get back into this game after the FOMC meeting today.

Disclosure: none