Shares of iShares China Large Cap (NYSEARCA:FXI) have been under pressure over the past few weeks. The FXI is an index that tracks large-cap Chinese stocks that trade on the Hong Kong exchange. After making a recent high at $41.90 on Sept. 13, FXI stock has fallen nine of the past 10 days and lost nearly 6% in that time frame. While tariff fears have exacted a toll, the recent selling has become overdone. And now it’s time to get back into undervalued and oversold Chinese stocks after the recent selloff.
The latest impetus behind the weakness in Chinese stocks was a report Friday that the White House might be considering some type of ban on U.S. investrments in China. As usual, details were sketchy and nothing was definitive.
Regardless, the news was taken seriously enough to send FXI reeling over 1% lower on the day.
Over the weekend, Treasury officials stated that the U.S. Treasury has no plans to block Chinese stock listings on U.S stock exchanges at this time. Indeed, such a move would be difficult to enforce at best and send a message that U.S. markets are not as open as purported to be. At the end of the day, it is highly likely just more bluster and a negotiating ploy as the tariff tensions continue.
Chinese stocks are cheap on a valuation basis. The current price-to-earnings ratio for FXI is just above 10, a comparative bargain to the current S&P 500 multiple of over 22. FXI is also cheap on a price basis. It is trading at the largest discount to the S&P 500 over the past year. I look for this relationship to begin to converge with Chinese stocks outperforming U.S. stocks over the coming few months.
FXI is getting decidedly oversold on a technical basis. Its 5-day RSI is back below the 20 level, which has signaled a bottom in the past. The MACD turned sharply negative, while momentum is also nearing overly bearish readings. Meanwhile, Bollinger Percent B is approaching a negative print.
FXI is also trading at a discount to the 20-day moving average and there is major horizontal support at the $38 area.
Are Chinese Stocks Ready for a Rally?
As the chart shows, it is usually a sign of an impending rally when all of these indicators align in this fashion. The prior four times this occurred led to a significant move higher in each instance. The average of these four rallies has been over 10%, implying an move back to at least the $43 area over the coming months.
Stock traders should look to buy FXI stock on any weakness and use the $43 area as an upside price target. A significant break of support at $38 makes sense for a stop level. FXI also carries a solid 2.16% dividend yield with only a 50% payout ratio.
Option players want to note that the current IV precentile is at only 32%, meaning option prices are somewhat cheap. This favors long option strategies when constructing trades. So to position for a pop in FXI, a simple call buy makes sense.
FXI ETF Trade Idea
Buy FXI Nov $40 calls for $1.00.
The maximum risk on the trade is the premium paid of $100 per contract. A move to the $43 target level would result in a nice gain of at least $200 on these options, or 200%.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at firstname.lastname@example.org.