Should You Be Worried About Your Chinese Investments?

by George Leong, B. Comm.

While stock markets in the U.S. are at a 10-month high, there are some concerns surfacing in China.

Chinese Premier Wen Jiabao, the country’s top economic official, warned that the country faces continued uncertainty and numerous hurdles in the road ahead. Jiabao also pointed to continued risk in the global economies. The comment is worrisome and could hamper the upside movement of the Shanghai Composite Index (SCI) and other global markets in the near term.

This is a time to be prudent. Chinese stocks were flying high, but some of you may have sensed that the fact that the benchmark SCI was up 80% this year was a warning flag of a pending correction. The valuation, while still reasonable, increased at a faster rate than was acceptable. Following the strong upward move, there was the formation of a bearish double top on the chart, along with a break below the trendline. The aftermath was not unexpected, as the SCI collapsed after the second top at just below 3,500.

In the process, the SCI plummeted over several weeks to the point where it was trading 20% lower than its peak, and it broke below key support at 3,000. With the decline, the SCI broke 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 you should 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 signal more downside moves or we could see an influx of buyers coming in and supporting stocks. The SCI rallied and broke back above the key 3,000-point level on Monday, but then sold off over two percent on Tuesday. There could be some sideways trading in the near term, as Chinese stocks are facing some selling pressure.

The risk with Chinese stocks is that the group is extremely vulnerable to mass selling, especially following the size of the rally we saw. Once sentiment turns bearish, the selling intensity can easily pick up speed and, before you know it, stocks are down 20% like what we just witnessed. The SCI could move back down to the 2,600-point level.

You need to be careful with any Chinese stocks you are holding. There have been some excellent returns this year, but you also need to protect your gains. Take some profits on the big winners and have some stops in place, especially if you have some aversion to risk and volatility.

At the same time, there also needs to be some calm. The keys with Chinese stocks are patience and careful monitoring. For instance, if you sold during the correction in 2008, you may have missed the excellent rally this year.

The next several weeks should give us a better idea on the SCI and whether the setback is temporary.