Do you really want to short the Chinese market?

Summary:  Chinese equities remain well off their all-time highs while US stocks surge higher. Are they an attractive investment, or will the current trade deal optimism fizzle as investors buy the rumour and sell the news?

The bull case

Momentum begets momentum. Despite the huge sell-off in Chinese equities last Friday (over 4% in some indices), the market rebounded well this week. As of Wednesday afternoon, we still have the Shanghai Composite and CSI 300 Chinese indices at approximately +27% and +24% year-to-date in USD terms. This is clearly the market signalling that the big stimulus measures from Beijing are feeding through and that the worst is behind us (for now). 

Regarding some negative sentiment about the YTD performance, it is important to bear a few things in mind:

China, together with several emerging market equity markets, endured a lot of pain in the last year. The Shanghai Composite was down approximately 30% last year. Meanwhile, the main US equity indices made new highs last year and a possible +5% move in the S&P 500 would be an all-time high record. Shanghai at approximately 3,000 is still close to -42% from the all-time high of 5,178. Moreover, unlike last year, the US seems to be significantly more motivated to realise a deal with China. 

Even though we might have seen the peak of the Federal Reserve hiking cycle, the market still has a very elevated net-long USD position – see the latest COT report from Saxo Commodities Head Ole Hansen for more on this. The world needs a weaker dollar to flourish, which should generally mean that structural headwinds for China, EM and commodities now become tailwinds on a softer USD, not to mention a lower cost of capital and easier financing for EM USD-denominated debt. 

The latest twist on all this is the European Central Bank’s pivot back into more stimulus, which we feel potentially signals ‘QE for life‘.

The bear case

This market is priced past perfection as it assumes the US/China deal to be concluded, but it ain’t over until its over. We are also likely in the middle of a buy-the-rumour (Trump/Xi deal) and sell-the-fact (the summit, if it ever happens) cycle. 

What is the next catalyst out there? Eurozone economic data continue to fold, and Germany is flirting with recession. In North Korea, ‘Rocket Man’ seems to be up to his antics again with the rebuilding of a site that was supposedly dismantled. Moreover, US Q1’19 earnings are still far away. 

Considering momentum, the Shanghai Composite was up 20% in USD terms by the end of February, which would add up to an annualised rate of +120%. The Chinese leadership wants to avoid another stock market crash like that seen in mid-2015, when the SHCOMP fell close to 50% from its all-time highs towards the lows of that particular year.

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