Chinese Internet stocks are setting up for a potential breakout

I believe we are witnessing a basing pattern that could lead into a bullish breakout for Chinese internet stocks. This pattern, along with some breadth and momentum indicator readings, is suggesting that the coming one to two years will see potentially significant gains in the sector. We must keep in mind, though, that the risk of buying stocks within a controlled environment such as China are always higher than the more traditional market environments. But, then too, are the potential gains if things turn out to be better in China than is currently thought. While I cannot predict the movements of a government, I can look at crowd behavioral patterns surrounding those policies on the stock market. From there, it is possible to project a potential outcome from that data that we do know. Lets take a look at some of that data:

% of Chinese Internet stocks > 200 day SMA

If you read my book “Smart Money/Dumb Money“, you know that I tend to use readings like the % of stocks over significant moving averages, along with new high/new low ratio indicators as a way to measure breadth-momentum. When there are too many, or too few stocks over their SMA’s, or too many/too few stocks putting in new highs vs lows on an index, we get an idea if the index will turn (up or down) soon. The chart below, courtesy of sentimentrader.com, is that of the % of stocks over their long termed simple moving averages. As I note in my book, when levels of about 20% or lower are hit & bounced off of on this indicator, it can lead to a rally for that index. That’s what is happening now for this index.

Panic is abating for Chinese internet stocks

Also from Sentimentrader.com, their composite of a variety of sentiment indicators pushed into one bigger-picture indicator has been very accurately signaling buy-points for Chinese Internet stocks. Right now, this compilation is signaling “buy”. Note the forward returns on the past signals of this indicator.

Long termed momentum indicator MACD is hooking up

Below is a chart of the KWEB Chinese internet stock ETF. I’ve noted the very prominent MACD crossover on the chart. Strong hook-ups like this on this longer-termed momentum indicator often result in significant upside – especially after a crash and burn situation as we’ve seen in this sector. I’d also like to note the tidy consolidation pattern on the chart of late. A breakout would be bullish.

Conclusion

This pattern, along with breadth and momentum signals, suggest that the bottom has likely occurred for the sector. While one cannot predict the precise timing of a breakout, it is looking favorable. The pattern and technical momentum/sentiment signals on these charts have roughly followed the path after other major panic bottom. This suggests rising prices over the next 1, 2, or 3 years, keeping in mind the risks associated with Chines politics. As an aside, we own a small position in a Chinese ETF. We anticipate adding to that position if/as/when the current consolidation pattern breaks out to the upside.