Can You Handle the Risk?

by George Leong, B. Comm.

I will need to do some hand-holding here when discussing China. The benchmark Shanghai Composite Index continues to have a negative bias, and it fell another 4.3% on Tuesday to below 2,800. The index has been on a downward correction of 20% since trading at a 52-week high of 3,478 in recent weeks. The index was up over 80%, but there was a sense that the rally was overextended and needed a pause and some profit-taking to readjust. This is what we are currently seeing now.

The chart shows a bearish double top and a break below the trendline. With the decline, the SCI has broken below its 20-day and 50-day moving averages, which is bearish. The 20-day moving average is holding above the 50-day and 200-day moving averages, but watch to see if it can hold. If the 20-day moving average breaks below, the SCI could decline further. The Bollinger Bands have also turned lower. Yet, given the selling, the SCI is technically oversold, so watch for some support.

There are some concerns here given the 20% correction. There are two ways of looking at the correction. It could point to a trend reversal and could signal more downside moves in the upcoming weeks. Or we could see an influx of buyers coming in and supporting stocks.

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Be careful with Chinese stocks, as a reversal sentiment could drive major selling in Chinese stocks on U.S. exchanges.

Many of you know that I have been and continue to be a big backer of Chinese stocks. China will continue to be one of the top major growth regions in the world. When you have 1.3 billion people and a middle class of about 300 million, you’ve got potential. In my view, no other country offers such incredible investment opportunities. Plus there’s the fact that China is a neighbor of the world’s second most populous country, India, where there are also excellent growth opportunities with over 1.1 billion people and excellent growth prospects. Imagine the combined markets when the disposable incomes in both countries rise upwards.

The bottom line is that China remains a key component of the global economic machine, and will need to stabilize its economy; otherwise, the ripple effect to the rest of the world could be devastating. The country’s GDP, which had been slowing, grew at 7.9% in the second quarter, up from 6.1% in the first quarter, according to the National Bureau of Statistics (NBS). The current valuations remain intriguing and the country remains a growth market for many sectors.

In spite of the higher risk in China-related stocks, I believe it would be an error to bypass the country. Investing outside of the U.S. helps to diversify returns and add some growth potential.

The key to invest in China is to be diversified. Invest only a portion of your capital in China. Besides small-cap stocks, you can also buy large-cap Chinese stocks or major U.S. companies with an expanding presence in China.

As we move forward, I continue to expect great potential and growing surfacing from China. The country has plenty of growth for the investor looking for international growth opportunities. Continue to add Chinese stocks to your well-diversified portfolio. Just be wary of the near-term volatility.