There are five ways to trade the economic growth of China. The first is trading the Shanghai Index using an ETF that tracks the Shanghai futures contract. The second is to use an ETF that tracks a selected group of Chinese stocks like the top 50. Some of these ETFs mix Hong Kong-listed red chips with mainland stocks. Others follow just mainland-listed stocks.
The third method is to invest directly in Chinese companies that are listed on exchanges outside of China. The fourth method is to invest directly in Chinese equities listed in Shanghai or Shenzhen using the Cross Connect facilities. Fifthly, the faint-hearted use indirect investment approaches, investing in companies which do business with China. Often these will also be foreign companies like Australian iron-ore miners, agricultural producers, or manufacturers of baby formula and vitamin supplements.
True to his performance over the past four years, US President Donald Trump has thrown a spanner into the works. This has disrupted two of the main methods of gaining investment exposure to China.
The first is the demand that the New York Stock Exchange (NYSE) delist a number of Chinese companies. The NYSE has vacillated on this demand, first indicating the delisting would be effective Jan 7, then delaying the process, and now hinting that the delisting is back on the agenda.
This delisting threat impacts some of China largest companies and a very large investor base. Investments in Alibaba Group, Tencent and other US-listed China stocks are now under threat. Once-delisted disbursements will be made to investors, but these will be based on the last traded price which will have been destroyed in the delisting process. Vacillation by the NYSE on delisting is not helping the share price.
Many of these Chinese companies have already explored Hong Kong listings, so access to them remains an option for investors outside of the US.
Of more direct concern is the as-yet-unknown fate of the index and China ETFs. Many of these products are created by US-based issuers. Technically, under the terms of Trump’s latest orders, these ETFs may need to divest themselves of the now 35 companies identified by the US as banned. This banning means that US “persons” — a term that includes companies — cannot own stocks in these companies.
An ETF based on the top 50 mainland China stocks will inevitably include some of these “banned” stocks. It is unclear if this means the ETF will have to drop these stocks from the grouping, so reducing the top 50 to a less representative top 45. This of course also implies a dilution in the efficacy of the ETF as an instrument for tracking and participating in Chinese economic growth.
The question is more challenging for the Shanghai Index-linked ETF. The Shanghai Index includes many of the stocks that have been banned by this executive order from Trump. It is not possible to separate out these stocks from the Shanghai Index values used as the basis for an index-linked ETF. Does this mean that an index ETF cannot be offered by American issuers because the index includes some of the banned stocks? This is currently an unresolved question.
Like so many of Trump’s executive orders, this is a poorly-thoughtout demand with a significant range of unintended consequences. Investors holding these instruments continue to watch carefully and hope that President-Elect Joe Biden will include this in the group of Trump’s executive orders which require overturning immediately.
Technical outlook for the Shanghai market
The Shanghai Index continues its strong rally breakout, reaching towards the initial target near 3,620. This breakout target is calculated using the width of the prolonged sideways trading band. These calculations help define potential targets for the index, but they do not indicate how the breakout trend will develop.
The Shanghai Index moved in a broad sideways trading band that has dominated activity for five months since July 2020.
Since that month, the index has oscillated around the centre line of the broad sideways trading band that has dominated the market. The first upside target near 3,540 is calculated by measuring the width of the upper section of the trading band and projecting this value upwards. The second target takes this value and projects it above 3,540 to give a target of 3,620. These are short-term targets.
The full width of the trading band is 235 points. The longer-term target of 3,690 is calculated by taking the full width of the trading band and projecting this value upwards from 3,450.
A characteristic of the Shanghai market is fast and extended rallies, followed by a sharp correction and consolidation. This developed this week, giving investors the opportunity to join the market around 3,540. The strong rebound confirms there is a good probability the market will resume the rally and move quickly to 3,690 prior to the Spring Festival holiday break.
The Guppy Multiple Moving Average (GMMA) relationships confirm trend strength. The lower edge of the long-term group of moving average in the GMMA indicator is above the 3,360 support level. The upper edge of the long-term GMMA is near the 3,450 resistance level. The wide separation shows good investor support for continuation of the uptrend.
The short-term GMMA shows traders strongly support the trend continuation. The short-term GMMA is well separated and this shows strong trader support for the trend. Any selldowns are seen as a buying opportunity and traders quickly come back into the market as buyers.
The current trend is tentatively defined with trendline A and this can be used as a warning stop-loss value. The key stop-loss points are the values of the trading band projections. Following a breakout above the trading band target level, the index often retreats and tests this level as a support feature. This is not an exact level retest, so the index tends to oscillate around the level as it did around the 3,540 level. Traders watch for the same consolidation and oscillation around the 3,620 level.
* Declaration of interest: The writer owns China stock and index ETFs.
