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China Parade & Market Boost Not Enough for Funds

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Two things have been very prominent in China - the economic weakness that is causing the market rout and government measures to prop up share prices. The Chinese government has made many moves to boost prices, including rate cuts and arranging for state-backed financial institutions to buy shares. However this time, the move is somewhat different, as it is believed to have been done to prop up prices before the lavish military parade to celebrate Japan's World War II surrender.

The Chinese Government mentioned this as the "Commemoration of Seventieth Anniversary of Victory of Chinese People's Resistance against Japanese Aggression and World Anti-Fascist War". According to a Financial Times report, “Traders and officials said the latest intervention was aimed at providing a “positive market environment” in preparation for a big military parade.” The resumption of large-scale stock purchase began last Thursday in the final hours. “This helped to lift the Shanghai benchmark index from a small loss to end the day up more than 5 per cent. The market rose by almost 5 per cent again on Friday,” reported Financial Times.

As it stands, the market boost is a result of intervention, which may decline going forward. Meanwhile the economic data is not supportive and reflects weakness for the second largest economy. Amid this, it is probably not a good time to make new investments in China equity funds. In fact, they emerged as the biggest losers in August.

Boosting Stocks Ahead of WWII Parade

By last Thursday, a measure of 50-day volatility increased to its highest point in 18 years. This was a result of indications that China’s government had withdrawn measures taken to prop up equity markets.

However, the Shanghai Composite rebounded last Thursday, gaining 5.3% as stocks surged during the last 45 minutes of the trading day. This was partially due to a resumption of share purchases by China Securities Finance Corp.

Last Friday, senior government functionaries said the country’s local funds will begin investing 2 trillion yuan ($313.05 billion) in stocks and other securities. The benchmark index surged 4.9% following this statement and other indications that the government was again providing support measures.

Officials and traders commented that these efforts were only intended to boost sentiment ahead of a major military parade to be held this week in China. Senior functionaries at financial regulatory bodies have confirmed that this was an exception. Going forward, the purchase of shares on a large scale will not take place.

Exception to Massive Share Purchases

The exception here relates to massive share purchases that the government started and ceased. A consortium of funds and institutions backed by the state, have together injected nearly $200 billion into markets over the last two months. This was part of efforts made to prop up markets which are down more than 37% since highs reached in mid-June.

Leading these efforts was China Securities Finance Corp., which has received around $483 billion from the government to purchase shares in an effort to boost a flagging market. According to exchange filings, most of its positions have been built up in larger companies.

Railways have been a particular favorite for the state sponsored fund, followed by healthcare, food and tech stocks. According to reports, it has invested around $32 billion in mutual funds. On the whole, it has become a major market player.

Changing Tack

However, according to the Financial Times, senior officials of the country’s regulators now believe that these efforts have been inappropriately implemented. This is because an excessive amount of information had been disclosed publicly.

Going forward, attempts to boost markets through share purchases will be ceased. Instead, officials will concentrate their efforts on identifying individuals who have worked to destabilize the markets. Suitable punishment will be meted out to those who have been identified as the guilty parties.

The major question is about how to strike a middle ground between ensuring that the market has a greater role and the need to shore up the markets and the economy.

Dilemma Continues

Despite the fact that market watchers are unsure about whether further market intervention will take place, it is likely that intervention will decline going forward. Recent flight of foreign capital had led to the IMF asking China to withdraw such measures. The country’s government is looking for the international body to provide its endorsement to the yuan as a reserve currency. The events of the last few days are indicative of the dilemma which China’s government faces.

Separately, several economic indicators from China signaled the slowdown may be deepening. Data on manufacturing was disappointing in nature, indicating underlying China’s economic weakness. Producer prices declined to the lowest level in six years in July. Additionally, exports recorded a greater than expected decline.

2 Funds to Sell

On this note, it would not be safe to make new bets on China mutual funds. Moreover, let’s look at 2 funds that should be avoided.

The following funds carry either a Zacks Mutual Fund Rank #4 (Sell) or Zacks Mutual Fund Rank #5 (Strong Sell) as we expect the funds to underperform its peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund. The minimum initial investment for these funds is within $5000.

US Global Investors China Region (USCOX - Free Report) seeks capital appreciation over the long term. Most of its assets are invested in equity and equity-related securities of firms located in China.

USCOX currently carries a Zacks Mutual Fund Rank #4. Over the last 6 months USCOX is down 14.2% and year-to-date loss is also 14.2%. Though 3-year annualized return is nearly 1%, the 5-year annualized loss is 3.6%. The annual expense ratio of 2.51% is higher compared to category average of 1.77%.

Templeton China World Fund Class A (TCWAX - Free Report) invests the majority of its assets in Chinese companies. The fund invests in ADRs, European and Global Depositary Receipts. It invests in companies of all sizes as well as small cap companies.

TCWAX currently carries a Zacks Mutual Fund Rank #5. Over the last 6 months TCWAX is down 19.5% and year-to-date loss is 16.9%. The 3-year annualized loss and 5-year annualized loss are 2.3% and 0.9%. The annual expense ratio of 1.85% is higher compared to category average of 1.77%.

About Zacks Mutual Fund Rank

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