What’s Going on with One of Our Favorite Markets

by George Leong, B. Comm.

Chinese stock markets appear to have hit a wall and that stands at around the 3,000-point level. There was some encouraging buying in the recent sessions, as the benchmark Shanghai Composite Index (SCI) rallied and broke back above 3,000 on August 24 before retrenching. The ACI fell 6.7% on Monday and there is fragility on the stock chart.

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.

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

Most 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. Add in 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 you have excellent growth prospects overall. 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.

In spite of the higher risk in China-related stocks, we 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.

As we move forward, we 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. At the same time, you also need to be aware of the near-term volatility.

If the SCI continues to fall further, we will likely see corresponding weakness in Chinese stocks listed on U.S. and Canadian exchanges. My advice would be to tread carefully and begin to accumulate stocks after dips. The reality is that Chinese stocks continue to have attractive valuations in spite of the higher risk.