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Last Hurrah for the China Trade?


It seems so -- and it might be best to start looking for lower prices.

In September 2012, we highlighted the Chinese economy as one of the leading targets for hot money flows due to its relatively strong (but declining) economic growth. Since then, the decline in economic growth appears to have slowed or leveled off. According to China Daily, "China's economy rose 7.4% in the third quarter of 2012, marking its lowest growth in more than three years and a slowdown for a seventh consecutive quarter. The country is scheduled to release fourth-quarter GDP and that for the whole of 2012 on Friday."

Ma Jun, chief economist of Deutsche Bank China, voiced expectations that China's GDP growth will accelerate to 8% in the first six months and further pick up to 8.5% in the second half of the year. In our opinion, such optimism in the face of the longer trend begs a disappointing outcome. We await the China GDP report with some trepidation, because it may affect our thesis on "hot money" flows.

In fact, the authorities in China, notably the Hong Kong Monetary Authority, have noticed (and appear to be taking appropriate measures) to stabilize the renminbi. According to the South China Morning Post, "Analysts said the massive money inflow into Hong Kong was caused by the ultra-loose monetary policy in debt-laden United States and the European Union, where central banks have been buying government bonds and mortgage-backed securities to maintain ample money supply and keep borrowing costs low. Through this so-called quantitative easing, the Western governments hope to stimulate economic growth and cut unemployment."

"The trend of hot money inflow will not change in the short term, especially after the US government's stepping up of the quantitative easing program," said AMTD Financial Planning general manager Kenny Tang Sing Hing . "Now that Japan has chosen a new prime minister, it is also widely expected to engage in similar operations to stimulate its moribund economy."

The flow of "hot money" from West to East does not appear to be viewed as a bad thing. According to Bloomberg, "China can increase by 10 times the size of two investment programs that allow foreign investors to buy securities on domestic markets, the nation's securities regulator said.

Stocks surged on the prospects that foreign funds allowed to invest in local markets will increase, said Bank of Communications Ltd. strategist Hao Hong.

"The possibility that foreign investors can buy shares, even if it's a possibility, is very bullish for stocks," Hong said in a telephone interview. "Guo's comments are very significant as they show that the government is trying to get bullish on stocks and it's a policy signal as well."

The Shanghai Stock Exchange Composite Index ($SSEC) has rallied since our article and may be approaching a set of resistances. The first resistance appears to be the June 2010 low at 2319.73. Some analysts look for prior highs and lows that signify either support in a decline or resistance in a rally. This area may be one such resistance that could slow down a rally or possibly stop it.

The second such resistance is what we refer to as the mid-cycle mean. A regression model suggests that a market decline may, on occasion, snap back to its mean value before resuming its prior trend. In our opinion, the primary trend of the $SSEC is down.

Good news tends to cluster at market tops. It would do well to remind investors not to fall head-over-heels in love with this market.

A view of Morgan Stanley China A Share Fund, Inc. (NYSE:CAF), the exchange-traded fund mentioned in our September article, shows an even stronger performance than the Shanghai Index. CAF has exceeded its mid-cycle mean and is fast approaching its weekly cycle top -- its maximum resistance. There is no assurance that this indicator will stop the rally, but it does remind us that the majority of the move may have already been made.

Our conclusion is that the China Trade is having its last hurrah and we are looking for lower prices.

See more from Anthony M. Cherniawski at The Practical Investor, and more from Janice Dorn, M.D., Ph.D. at Trading With Art and Science.
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