Editor’s note: Any and all references to time frames in China longer than one trading day are for purposes of market context only, and not recommendations of any holding time frame. Daily rebalancing ETFs are not meant to be held unmonitored for long periods. If you don’t have the resources, time or inclination to constantly monitor and manage your positions, leveraged and inverse ETFs are not for you.
It’s been a brutal couple of years for Chinese stocks, but they recently had their best week since 2015 1. In early November, traders aggressively bid up Chinese shares because of renewed optimism for China relaxing its zero-COVID policy and indications of positive findings in the audits of US-listed Chinese companies.
For an economy hit by rolling lockdowns for the better part of three years, some traders are betting that even the slightest relaxation in zero-COVID could jumpstart the Chinese economy to outperform the rest of the world. Of course, lingering worries over China’s real estate market, a potential standoff with Taiwan, and other geopolitical risks could kill the rally and push Chinese stocks to fresh multi-year lows.
The recently gapped up* aggressively. This could potentially indicate a reversal of the multi-year downtrend in Chinese stocks, should we continue to see positive outcomes on a few fronts. On the other hand, this could simply be an aggressive pullback within a longer-term downtrend.
Below is a chart of the FTSE China 50 Index* as of November 9, 2022:
The Reopening Rumor Mill
Rumors of the end of zero-COVID have encouraged bullish China traders although the Chinese government hasn’t confirmed anything yet. Chinese markets can move on unsubstantiated reports and rumors because the government releases so little official information. That’s why an unverified screenshot purporting to be a plan for China reopening ignited a strong rally in early November. This momentum sparked excitement about another report that an ex-Chinese government disease-control expert told a Citigroup conference to expect significant changes to China’s aggressive COVID policies.
Beyond the speculation, China’s taken concrete steps to ease its restrictive approach during the pandemic, like ending its program to penalize airlines for bringing COVID into the country. In the same vein, Hong Kong, which many call the “pilot program” for China’s reopening, plans to allow tourists back into amusement parks and museums.
As with all things related to trading China, it’s dynamic, and could dramatically change tomorrow without definitive announcement times or potential catalysts.
US Audits a Success?
Another cloud handing over Chinese stocks in the US is the Public Company Accounting Oversight Board (PCAOB), a non-profit who oversees audits of public companies, conducting audits of US-listed Chinese firms. Bloomberg recently reported that the board completed its first round of inspections ahead of schedule.2
A positive outcome in these audits could prevent 200 US-listed firms from potentially delisting and perhaps lift a weight from these stocks.
With this in mind, traders have already begun to bid up American Depositary Receipts (ADRs) even without an official statement from the PCAOB. However, Bloomberg reported the board might file an initial report the November-December time frame.2
Any statement from the PCAOB has the potential to move Chinese-listed ADRs in either direction, many of which are holdings of the underlying index, the FTSE China 50 Index, for the YINN seeks to provide 300%, before fees and expenses, of the daily performance of the FTSE China 50 Index while YANG seeks to provide 300% of the inverse (or opposite), before fees and expenses, of the daily performance of the FTSE China 50 Index.
China’s Relative Monetary Policy Strength
China may have a brighter monetary policy backdrop than the US and other regions. In a time when traders are more focused on central bank policy and its impact on markets and liquidity, this is an important distinction.
In the US, the Federal Reserve is on one of its most aggressive rate hiking campaigns in recent history, taking the US economy from near-zero interest rates to a tightening regime with markets pricing in several more rate hikes in 2023. And with inflation refusing to fall from historically elevated levels, the Fed may have to do more to cool the economy with tighter monetary conditions for longer.
In contrast, the People’s Bank of China (PBOC) is on a campaign of modest monetary easing, making small cuts to interest rates periodically. The PBOC has been steady in declaring that it has room for more dovish action, which isn’t lost on investors hanging on central bankers’ every word.
While monetary conditions aren’t ideal, China is easing into declining growth, while in the US, the Fed is aggressively tightening into an anticipated recession as inflation continues to run hot. The divergence between the world’s two largest economies may attract traders, especially if the US Consumer Price Index (CPI)* prints come in hotter than expected.
Should we see progress in the post-COVID reopening and US audits, China’s friendlier monetary policy backdrop could fuel further rallies.
Looking ahead, the PBOC makes its next interest rate decision on the evening of November 20. More dovish posturing could provide a lift to Chinese stocks.
The Key Factors to Watch
For traders looking to play both sides of the China trade, here are some key dates and news items to look out for in the coming weeks:
- Chinese stocks will likely be highly sensitive to any news regarding reopening plans and a relaxation in zero-COVID policy. In short, the slightest hints of policy changes could trigger big market moves. So some reading of the tealeaves is required, but the ultimate “all-clear” is likely when Chairman Xi changes his tune.
- The hopes for many Chinese companies to remain in US capital markets hinges on the outcomes of US-led audits by the PCAOB. Bloomberg estimates the board will make an initial report in the coming weeks.2 However, expect possible leaks to the media and potential market head fakes between now and then.
- China has monetary policies that are significantly more market-friendly than the US right now, and Chinese officials indicate they have room to continue. The two largest central banks are treading very different paths right now and look to the PCOB’s interest rate decision on November 20 to see how things continue to unfold, especially with another US CPI print in the rearview mirror.
Subtle signals of good news on the horizon created this recent bounce in Chinese stocks, but it likely needs more fuel in the form of concrete catalysts to keep it going. Failure for any bullish catalysts to materialize could kill current momentum in its tracks and create opportunities for China bears.
1 China – best week since 2015: https://www.bloomberg.com/news/articles/2022-11-04/china-stocks-head-for-best-week-in-two-years-on-reopening-bets
- A “gap up” in financial markets is when a security opens higher than the previous day’s high, leaving a gap between the two days of price action.
- FTSE China 50 Index (TXIN0UNU) consists of the 50 largest and most liquid public Chinese companies currently trading on the Hong Kong Stock Exchange as determined by FTSE/Russell. One cannot directly invest in an index.
- Consumer Price Index (CPI) measures the average change in prices over time that consumers pay for a basket of goods and services.
Leveraged and inverse ETFs pursue daily leveraged investment objectives, which means they are riskier than alternatives that do not use leverage. They seek daily goals and should not be expected to track the underlying index over periods longer than one day. They are not suitable for all investors and should only be utilized by investors who understand leverage risk and who actively manage their investments.
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