Chinese stocks are once again getting pummeled in front of Wednesday’s U.S. trading day. But in a market made up of stocks, remember as well that there’s more than just one market — even in China.
And as one of those markets for Chinese stocks is the concentrated iShares China Large Cap ETF (FXI), the time is looking right to begin positioning like a bull, rather than a bear … or a sheep.
It’s the Year of the Sheep in China. But when it comes to Chinese stocks and FXI, this pragmatic strategist would advise against becoming a sheep — don’t get caught up in the bear-market hysterics being served up by the media.
Sure, more speculative Chinese A-shares — represented by the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (NYSEARCA:ASHR), which ran up roughly 150% this past year — make the case that there probably is a bit more downside for those types of Chinese stocks.
But let’s do ourselves a favor and not stereotype.
Those sheepish bears may also argue the Chinese government hasn’t “responded appropriately” to the country’s economic slowdown, and that “government cheerleading” and easy money via loose monetary policy are two twin evils behind the stock market bubble in Chinese stocks, according to Brown Brothers Harriman’s global head of currency strategy.
However, without even getting into the politics of ZIRP and QE3 and how our own economy is so robust and our market(s) deservedly get to walk magically on water, the case for large-cap Chinese stocks was made yesterday at Barron’s by Fredrick Jiang.
Jiang is the fund manager behind the top-notch Ivy Emerging Markets Equity Fund (IPOAX) and an investor with firsthand and solid insight into China — and one good reason for our nod in looking bullishly at large-cap Chinese stocks via FXI.
FXI vs SPY Monthly Stock Chart
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Aside from scratching my head regarding government interventions and asking, “Are we really that different?” I did want to point out where the U.S. is in fact, very different. Despite all the finger pointing over those very expensive and speculative Chinese stocks, the monthly chart comparing FXI to the SPDR S&P 500 ETF (NYSEARCA:SPY) tells a very different story.
The solid magenta line is the SPY. Chinese stocks represented by FXI are shown as monthly candles. Notice the difference since 2009? In the U.S., where the Fed has acted as cheerleader for the SPY, the steady uptrend has outpaced FXI by approximately 115%.
And with the current bear market correction of 22% in FXI, the ETF is back below its 2010 highs.
FXI Daily Chart
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Next, I thought it was also important to look at just how FXI and those much stronger-value, large-cap Chinese stocks got back to those lowly levels of 2010, as it’s been very extreme the past several sessions, with Tuesday’s bearish action taking the icing on the cake.
On the provided daily view going back to China’s go-go days in April, I will admit the last 20% hurrah to the upside was indeed a rather fast and questionable affair.
At the same time, thanks to the hard drop from April’s highs, we can now say that Chinese stocks are in a bear market. FXI has suffered a correction of just more than 20%, and the action has proven even more extreme over the last several sessions.
The severe decline in the FXI’s constituent large-cap Chinese stocks was dramatically punctuated by Tuesday’s spectacular gap below the 200-day simple moving average to test the 62% retracement level, with FXI trading well outside its lower Bollinger Band.
What’s next?
Aside from still lower and oversold prices, let’s see about pricing a long call for the occasion.
FXI Bullish Option Strategy
FXI is opening Wednesday’s trading off about 5% to just below $40. Looking at the options board and estimating prices based on this change; the Aug $42 call for roughly 85 cents to $1 is an interesting way to play the short-term oversold condition.
If large-cap Chinese stocks find a (deserved) bid in the next couple sessions, the contract can double in price if FXI manages to climb back to around $42.50.
On the downside, as Chinese stocks are still in a freefall and oversold or not, we can’t expect to call an exact bottom. We’d use a 10% money stop of $37.76 (black horizontal line on daily chart) in FXI that’s based on last night’s close near $42.
If triggered, it would make for a less graceful exit, but it would help further reduce the limited risk of this call contract by approximately 50% of the debit paid.
Disclosure: Investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT.
