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An investor, center, speaks to another while they look at the stock price monitor at a private securities company on  Aug. 3, 2012 in Shanghai, China. (AP)

An investor, center, speaks to another while they look at the stock price monitor at a private securities company on  Aug. 3, 2012 in Shanghai, China.

(AP)

ETFs

All signs finally point to a rally in Chinese stocks Add to ...

Finally, after a three-year downtrend, the Chinese equity market has an attractive investment outlook. Technical, fundamental and seasonal influences have come together at the same time, a combination that has not existed during the past three years.

Recently issued data shows that China’s economic finally is showing signs of at least stabilizing near a 7.5 per-cent annual rate. Its official October Purchasing Managers Index released today recovered to 50.2 after struggling below the 50.0 level for most of 2012. An Index above 50.0 implies that economic growth is expanding once again.

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The improvement is directly related to action by the People’s Bank of China to add economic stimulus. The Bank pumped the equivalent of $50-billion (U.S.) into the economy on Sept. 25 and another $42-billion on Oct. 9. The International Monetary Fund is expecting China’s economy to improve to a 7.8 per cent rate by the end of 2012 and to an 8.2 per cent rate by the end of 2013.

The recovery comes at an interesting time in China’s political history. China’s top political officials change every 10 years. The regime change to the next generation of leaders happens next week. The new generation is younger, more technologically savvy and more committed to domestic growth than China’s current leaders.

The Shanghai composite index, at 2,069, has an improving technical profile. After falling 63 per cent from its all-time high in 2007 at 5,523, and after dropping 40 per cent from its 2009 high at 3,378, the index is forming a potential bullish reverse head and shoulders pattern. The pattern is completed on a break above 2,145. Implied upside technical target on a break above the pattern is 2,300. Short-term momentum indicators are oversold.

The index has been outperforming the S&P 500 index since mid-September. Preferred strategy is to accumulate Chinese equities at current or higher prices prior to the index moving above the 2,145 level.

Seasonal influences for the Shanghai composite index have just turned positive. The optimal time to own Chinese equities is from the end of October to the end of April. (See the above infographic for a 10-year seasonality chart on the index.)

The easiest way to invest in China is with exchange traded funds (ETFs). Investors with U.S. dollars can choose between 12 ETFs listed on U.S. exchanges and investors with Canadian dollars can choose between two ETFs listed on the Toronto Exchange.

Only four U.S.-listed ETFs with a market capitalization in excess of $250-million are worth considering for investment purposes. Each has unique characteristics.

By far the most actively traded China ETF is iShares FTSE China 25 Index units. The Index tracks twenty five big cap Chinese equities. A word of caution! The index is heavily weighted in one sector. Financial services represents approximately 51 per cent of the index. Net result is that units have a relatively low correlation with the benchmark Shanghai composite index. Management expense ratio is 0.72 per cent.

Investors looking for an actively traded security that has a high correlation with the Shanghai composite index might consider the Morgan Stanley A Fund, a closed end fund that owns a more diversified portfolio than the iShares unit.

Other actively traded U.S.-listed ETFs include SPDR S&P China ETF, PowerShares Golden Dragon Halter USX China Portfolio ETF and the Guggenheim China Small Cap Index ETF.

The two Canadian-listed ETFs are BMO China Equity Hedged to CAD Index ETF and iShares China Index Fund. A word of caution! Liquidity in these ETFs is sparse.

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