MARKETS SPECTATOR: China rising

China exposed stocks are on a tear as investors realise the bearish view has not played out. Now hedge funds are scrambling to cover short positions, adding to the sharp rise in China related equities.

The recovery in China is going to be one of the major themes of 2013 in my view. And today’s release of ‘as expected’ inflationary data for December shows that inflationary concerns aren’t looking like too much of a headwind at the moment.

As I wrote recently, (Is China due for a rebound? October 15) I used the outperformance of key China ETF’s, which are open to foreign investors as the basis for my call on why we might soon see a rebound in the Shanghai Composite market.

I think it’s a good idea to once again take a look at these ETF’s and see how they are tracking.

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Source: Iress

What the above chart shows us is that the Shanghai Composite has rebounded very strongly over the last 3 months, or basically since the once in a decade change of power was finalised in November. However, at the same time, both the small cap and FTSE China 25 ETF’s have continued to gain at the same rate.

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Source: Iress

The above chart of the iShares FTSE China 25 ETF looks very bullish indeed. The last week or so saw the ETF break up through major resistance and successfully pull back and re-test the support level. The last two days has seen it move higher from that support level on good volumes which an encouraging sign.

The chart of the small cap ETF basically mirrors the above chart.

As is frequently the case, the western world was simply too bearish on China right at the bottom of their ‘economic slowdown’. It’s now very obvious that the Western world completely misunderstood and underestimated the disruption the once in a decade transfer of power would have. Decision making across the country ground to a halt as big wigs all vied for positions within the new regime.

Now that all the dust has settled, it looks like the China train is well and truly back on the tracks, with the Western investment community frantically trying to catch up and jump back on board.
This is the main reason I am so bullish this year. While most of the investment community was underweight China in both relative and absolute terms, much of the hedge fund world was short China-facing assets.

Now we’re seeing a situation where hedge funds are trying to buy back their short positions in a rising market, which is like pouring petrol on a fire. And amongst that, everyone else is trying to increase their exposures to at least in line with benchmarks so that they’re no longer going backwards. This all combines to create an incredibly bullish environment.