A quick update on china

Today I want to offer a quick follow-up on China. At the end of July in this blog, I explored the idea of China as a contrarian trade. My prime criteria for investing in China was that I had to see the index base. That is, no more lower lows, and a confirmed test of support. That base does seem to be in the works. The Chinese market has been volatile, especially with the potential risk of a collapse of the Evergrande Property Developers group. Potential investors should bear in mind the true risks of that company folding. Some call such an event as potentially a new Lehman Brothers situation. Like the domino effect, it could create a systematic unwinding of stocks in China and the world.

Since predicting such an event is pretty hard to do, all we can look at is the charts. And follow a money management process. This is especially important when looking at an early entry into a highly volatile situation. Its either a value opportunity or a continuation of a mess that only gets worse. We shall see. As such, my suggestion on my original blog was to treat it as an aggressive position, and to not commit more than 1/3rd of the amount you would eventually want in the trade. Buying higher on a base breakout is the safest way to play this type of trade. The chart below is that of the China ARCA. The NYSE Arca China Index is a modified equal weighted index comprised of selected publicly traded stocks and American Depositary Receipts (“ADRs”) of companies with significant exposure to the Chinese economy. Note the base – which comes in near multi-year support – seems to be holding….so far:

 

Contrarian indicators suggest a buying opportunity
Despite the bearish views of the technology and real estate sectors in China, there are some contrarian indicators suggesting that opportunity may be afloat. Sentimentrader.com posts a “Panic Breadth Composite” to help identify when a particular market looks like it’s suffering panic-level selling pressure. This composite includes nine breadth metrics that have a good record at highlighting overwhelming internal selling pressure. The chart below illustrates the success this indicator has had in spotting oversold markets that are about to turn up. The indicator offers a “buy” signal when it rises above the horizontal “panic” line. Currently, the composite is suggesting another such opportunity has arrived.

China’s steps with property developers will likely have the most impact on these stocks and even the broader Hang Seng index. Even after selling pressure like this summer, the index hasn’t yet suffered full-out capitulation conditions, but it’s getting close. Internal selling has been significant enough to consider it heavily oversold, which typically means a multi-month rebound according to this indicator. For more on contrarian investment tools, read Smart Money Dumb Money.

Conclusion

Buying into the Chinese market isn’t for the mild mannered. However, for investors with a higher risk tolerance, there may be opportunities. Bearing in mind the current Evergrande situation.

As an aside: Today, Craig and I examined a new quantitative analysis software program. At ValueTrend, we’re always exploring new quantitative research tools to help us find and filter trading ideas. Our continuous quest for optimizing our research efficiencies aids ValueTrend in finding better trading ideas. That in turn benefits the risk-adjusted returns our clients enjoy. But some of the ideas we research  trickle down through this blog. So, our desire to ever – increase our trading and investing efficiency benefits not only our clients, but blog readers too!

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