The Global Guru: Is the Bull Back in the China Shop?

China badly underperformed most global stock markets for most of 2012. Despite coming on strong at the end of the year, China even underperformed the crisis-wracked Greek stock market.

But recent economic data from the Middle Kingdom is breaking bearish investors’ sentiment. The Shanghai Composite stock market index has been surging of late. Since hitting a low of 1960 on Dec. 3, it has jumped 18.8% in just eight weeks.

Why I am Still a China Skeptic

Long-time readers will know that I am deeply skeptical of the “China Miracle” — at least as a way for investors to make their fortune.

First, China has been a lousy investment for stock market investors over the past five years. Chinese stocks are not only down 20% from where they were in January 2008, but they also have underperformed broader emerging markets by that same percentage.

Second, many investors, including yours truly, were burned badly by fraudulent small-cap stocks coming out of China.

Finally, I still believe that much of the investment that has driven China’s gross domestic product (GDP) expansion over the past decade was “malinvestment” — history’s biggest government boondoggle that makes U.S. government-funded “bridges to nowhere” look like small-town municipal graft.

In short, I still fundamentally agree with China bear Jim Chanos’ famous pronouncement that China is “1,000 times worse than Dubai.”

Why I think China is a Good Short-Term Trade

Yet, as a trader, I must be flexible in my views.

If there is money to be made over the short term, I have no compunction about investing in a market.

And here’s why I think the Chinese stock market will continue to power ahead in the weeks ahead.

First, the Chinese economy has not stumbled, as I and many other bears were expecting.

December’s flash factory purchasing managers’ index came in at 50.9, the highest in 14 months and the fifth consecutive monthly gain. Any number above 50 represents expansion. New orders rose to 52.7, also a fifth consecutive monthly rise. Electricity output — a more reliable indicator of economic conditions — also rose 7.9% in November from a year earlier, the fastest pace this year.

In line with these numbers, China announced that real GDP growth hit 7.9% year over year in Q4, roughly in line with consensus forecasts of 7.8%. Full-year growth was 7.8%, slightly better than expectations of 7.7%.

China’s biggest government-owned bank — the Bank of Communications — is already talking up 2013, forecasting that it will hit 8.5%, thanks to rising demand from the United States and Europe. It estimates that exports will rise about 8.5% this year from 2012 and imports will climb by 10%.

Second, the top-down efforts of China’s incoming government are having an impact. Wasteful fixed asset investment has slowed across the manufacturing, infrastructure and property sectors due mostly to restrictions on the real estate markets. Personal consumption among Chinese consumers is rising as China’s mandarins try to achieve a more balanced approach to economic growth.

China also recently scrapped a ceiling on investments by sovereign wealth funds and central banks in its capital markets in an effort to encourage long-term foreign ownership and to shore up the slumping stock market.

Finally, at December’s Central Economic Working Conference, chaired by Li Keqiang, the incoming premier, the government “re-set” its commitment to Chinese reforms. This comes on top of a recent trip made by China’s new Communist Party chief and future President Xi Jinping to Guangdong Province across the border from Hong Kong — a trip that recalled a 1992 swing through southern China by then-paramount leader Deng Xiaoping to re-launch economic reforms.

Goldman Sachs made Chinese stocks one of its top picks for 2013. Institutional investors now are re-entering the Chinese market after a long absence, increasing their bets on a Chinese rebound so they don’t miss the boat.

How to Profit from the Chinese Rebound

On Dec. 17, I recommended my Bull Market Alert subscribers bet on China’s rebounding stock market.

In fact, I was so convinced, I recommended a leveraged bet through the ProShares Ultra FTSE China 25 (XPP). This exchange-traded fund (ETF) corresponds to two times (2x) the daily performance of the better-known iShares FTSE China 25 Index Fund (FXI).

Since then, the ProShares Ultra FTSE China 25 (XPP) has soared 12.29% — and Bull Market Alert subscribers booked quick options gains of 115.38% and 124.04% by Jan. 3.

The bottom line?

Despite my long-term skepticism about China, as long as global markets retain their current “risk on” bias, this bet on a Chinese rebound has plenty of short-term upside.

To read my e-letter from last week, please click here. I also invite you to comment about my column in the space provided below.


Nicholas Vardy, CFA
Editor, The Global Guru

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