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China ETFs: Bull or Bear in the Year of the Goat?

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News about the Chinese economy has been hitting headlines for wrong reasons. The economy expanded at the worst pace (7.4%) in 24 years in 2014. However, China divulged some good news to start the year of the Goat in the form of a four-month high manufacturing sector data.
Astrologers predict ‘accidents and an unstable economy’ in the year of the Goat (per the Chinese lunar calendar) and ‘finance and wealth to be favorable’ if exercised with ‘caution as there will continue to be volatile political situations causing economic activity and prices to fluctuate’. While it would be unfair to go all astrological before investing in Chinese securities, the current trend points only to instability.

The latest manufacturing data, which cheered up the China equities ETF space forcing many to take this as the beginning of the China bull ride, reveals possibilities and perils. Export orders contracted at the steepest rate in 20 months as per a private survey, indicating that the world’s second largest economy has to go a long way to attain the ground lost. Muted overseas demand and acute deflationary worries are constantly posing threats.

Manufacturing Data in Detail

The data revealed that the flash HSBC/Markit Flash China Manufacturing Purchasing Managers' Index rose to 50.1 in February, an increase from last month’s final reading of 49.7 and above market expectations of 49.5. The most important point is that China’s manufacturing activity expanded this month for the first time this year.

We believe that the all-important Chinese New Year on February 19 was one of the reasons for the uptick in domestic demand, absence of which might result in sluggish manufacturing data in the months to come. The frightening point is that the employment in factories contracted for the 16th consecutive months as firms fired workers in the wake of soft business environment. Economists now forecast a growth rate of 7% in 2015, cooler than the year-ago rate.
It’s not that the Central Bank (PBOC) is sitting idle. It rolled out a host of policy easing measures in the last few months and even cut the reserves requirement ratio (RRR) earlier in February, but the waning growth points toward the need for more aggressive policy easing (read: Policy Easing Puts China ETFs in Focus).
ETFs to Watch
Investors are advised to keep an eye on China ETFs after the bullish manufacturing data. In the large cap sphere, one can expect activity in iShares MSCI China Index Fund (MCHI), iShares FTSE China 25 Index Fund (FXI), SPDR S&P China ETF (GXC) and PowerShares Golden Dragon Halter USX China Portfolio (PGJ - Free Report) . These funds are 4.94%, 4.52%, 2.8% and 3.9% up so far this year (as of February 24, 2015).

However, investors should note that small caps have been the real winners this year on the rise in domestic demand and the PBOC’s special easing package to shore up smaller companies. For investors willing to bet on this space, funds such as db X-trackers Harvest CSI 500 China-A Shares Small Cap Fund (ASHS), Market Vectors ChinaAMC SME-ChiNext ETF (CNXT) and iShares MSCI Hong Kong Small-Cap ETF should be kept on the radar. CNXT, ASHS and EWHS are up 23.7%, 12.2% and 2.7%, respectively, so far this year (as of February 24, 2015) (read: China A-Shares ETFs Explained).

Bottom Line

From the above discussion, one can understand that astrologers’ forecast looks correct at the current level. The Chinese economy is presently sitting on a fence with returns and risks on both sides. So, the year of the Goat has to be a ‘volatile’ one and needs to be watched with a ‘caution’.

There are a number of headwinds still facing the Chinese economy, including shadow-banking activities and money laundering from mainland China to other peripheral destinations like Macau. A group of economists believe that the government’s excessive focus on anti-corruption activities may in fact hold back GDP growth (read: China ETFs to Watch on Margin Trade Ban and GDP Data).

Whatever the case, we can expect a volley of easing measures from the PBOC if the economy turns up with offhand readings as the year moves along. And whenever this happens, the market should jump (read: Should You Buy China ETFs on Stimulus Bet?). 

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