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China ETFs Struggle on Weak Data, Bailout Speculation

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Although many emerging markets started the year on a solid note, it is now starting to look like that optimism might have been short lived. After all, arguably the most important emerging market, China, just reported some disappointing manufacturing numbers, calling into question the health of one of the nation’s most important sectors.

Manufacturing Data

The data showed that the flash Market/HSBC Purchasing Managers’ Index fell to 49.6 to start the year, a decline from last month’s final reading of 50.5. The figure was also below the key contraction/expansion demarcation point of ’50.0’ signaling that the Chinese manufacturing segment was actually shrinking.

This is a bit of a surprise considering that many developed markets are coming back pretty strong and are seeing rising demand. However, there has been some sluggishness in the domestic Chinese market, which along with some other issues in the nation, could point to some big concerns for the continuation of China’s longer term growth story (see China ETF Investing 101).

Debt Issues Too

The weakness in manufacturing comes on the heels of some serious worries over debt problems in China, and the potential for a large string of defaults. These concerns are largely tied to Chinese Wealth Management Products (WMP), which hold over $2 trillion and often offer guaranteed returns to investors.

However, at the end of the month, a major Chinese Wealth Management Product is due to mature and it doesn’t appear as though it will have enough capital to payout investors their guaranteed return. Some are speculating that the Industrial and Commercial Bank of China, the entity that sold the WMPs in question, will step in to bailout investors, but an ICBC spokesperson squashed this idea.

Now, the thinking is that the WMPs will be allowed to default and that this will teach Chinese investors that these products are by no means guaranteed. While this may be an important lesson, it could send a shock through this huge market, and call into question the rest of the WMP space, a situation that could have drastic consequences.

Market Impact

In this backdrop with these two huge issues, Chinese shares have taken a large step back and were down significantly in Thursday trading. In fact, many Chinese ETFs led the emerging market world lower in Thursday trading, easily underperforming broad indexes on the day (see The Right and Wrong Ways to Invest in China ETFs).

In particular though, the financial and large cap space were hit hard in the session and led the China ETF space lower. The trio of the PowerShares Golden Dragon China ETF (PGJ - Free Report) , the iShares China Large Cap ETF (FXI - Free Report) , and the iShares FTSE China ETF (FCHI) all finished the session lower by nearly 4.5%.

Meanwhile, some sector funds were also heavily impacted by the news with the tech and financial-focused funds leading the way on the downside. The Guggenheim China Technology ETF (CQQQ - Free Report) and the Global X Nasdaq China Technology ETF (QQQC - Free Report) lost, respectively, 4% and 3.6% for the session, while the Global X Financials ETF (CHIX - Free Report) lost 4.7% on volume that was roughly four times normal (see the Guide to China Tech ETFs).

As you can see, the pain in China ETFs was pretty widespread, though the high beta and financial-heavy funds definitely took the brunt of the selling pressure. It also appears that the somewhat isolated A-Shares market held up better (despite sometimes heavy financial concentrations here too) as the trio of (ASHR - Free Report) , PEK, and CHNA all lost less than their counterparts listed above, though volume wasn’t really elevated either.

This suggests that the panic is focused on the big companies and those that really ran up last year (such as technology) smaller cap securities have been spared—so far— while more industrial sectors have also held up, so the gloom isn’t universal yet by any means.

Bottom Line

Thanks to the worries over manufacturing and the debt problems, China ETFs sold-off heavily in Thursday trading. The funds are down for the year, and could face more rockiness in the months ahead too (see 3 Emerging Market ETFs to Watch for Political Issues in 2014).

This may be especially true if the WMP issue infects the Chinese economy and leads to a huge blow in confidence. If this is the case, it could led to even less domestic demand, cause another downward move in the manufacturing sector, and greatly harm the Chinese economy in the near term.

For this reason, investors need to pay close attention to their China ETF investments over the next few weeks, as it may be time to let these sit on the sidelines for a bit. Volatility looks likely to pick up, and if the WMP issue hits on January 31st, the Chinese New Year could be one to remember for investors this time around.

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