Soft Landing or Hard Landing? No matter the news of the day and what it points to as it relates to China’s economic recovery, the 2000 level has been a magnet for the Shanghai Composite since the end of 2012:
While the index has had its share of healthy bounces off of 2000, those bounces are getting shallower and shallower, as seen in the wedge pattern that has formed. If you were just looking at the chart without any knowledge of the underlying it would be a safe assumption that this thing is gonna break one way or the other and probably soon.
But because we know it is the largest equity index in China, and we know that much of the broader economic data is managed by the big shots above, this has not been an easy one to call. The index is comprised of mostly A-Shares, which are Chinese companies incorporated in China, but are for the most part not eligible for foreign investment. That is one reason for Western investors’ interest in FXI (iShares China Large Cap etf) which is comprised of H-Shares. H-Shares are Hong Kong listed companies with most components’ large cap State Owned Enterprises (SOEs) that trade at a premium due their global scarcity with an handful like China Construction Bank, China Mobile, Industrial & Commerce Bank, Bank of China, Petro China and CNOOC representing 40% of the etf’s weight. SO banks and energy. That’s the FXI trade no matter which way you chose to play. Both sectors are extremely sensitive to fluctuations in centrally planned economic policy.
As a macro tourist, I can arrive at the distinction between the performance of the FXI vs the Shanghai Comp. The FXI is up 20% in the last year, and flat so far in 2014, while the Shanghai Comp is up only 3% in the last year, down 10% in the last 2 years, down 30% in the last five and finally down 4.3% ytd. Chinese holders of equities who are on the ground are voting with their investment portfolios, while foreign investors are placing more stock in the Chinese government’s ability to manage their downturn in growth into a soft landing.
Last night, China released a reading for manufacturing activity in June (PMI) that came in a 7 month high. Fairly bullish right? Well, no one seemed to care. The Shanghai Comp closed down slightly, and the FXI is trading down a little more than 1% on our shores. So while the news feels incrementally better, the locals don’t seem to care, and the 18% bounce off of the March lows in the FXI might have discounted any near term positive news flow.
The 6 month chart below of the FXI shows the recent volatility, but also interestingly shows the nearly perfect double top just made at the prior high from the last day of 2013:
For those who think the price action in local shares will ultimately find its way to the H Shares and think that an early summer malaise as it relates to market volatility may give way to rockier times in August or September I would look to finance the purchase of downside puts, and use calendar. While last week’s failed breakout in FXI is certainly compelling from a technical standpoint, today’s gap lower would be hard place to put on a new short. I would look for a fill of the gap and a failure to enter a bearish trade, possibly closer too $38 in the coming days.
Hypothetical Trade – FXI ($37.45) Buy the July/Sept 36 put calendar for .62
-Selling July 36 put at .33
-Buying Sept 36 put for .94
Break-Even on July Expiration:
-Profits are maximized at 36 on July expiration. Slight moves above and below that strike are also profitable with big moves higher or lower putting the structure at risk of losses on expiration.
-Max risk is 62 cents
Rationale: The next couple weeks with the July 4th holiday coming up could be slow trading. Those looking to make directional long premium bets will want to finance the purchase of longer dated options by selling shorter dated ones. This strategy will help keep you in the game in such a low vol environment.
That being said, I have little edge when it comes to making trades based on macro views. I have no idea what is going on in China, and quite frankly few do, which is one reason why I have not traded FXI since last summer. But the set up from a technical and sentiment standpoint could be interesting if the entry is a little better and the structure makes sense. Stay tuned.