Might Be Time to Back Off China

 | Apr 17, 2013 | 10:00 AM EDT  | Comments
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Stock quotes in this article:

FXI

China, the emerging-market story for the past decade, has been a commodities powerhouse that's sported booming real estate prices, and a 10% annual rise in gross domestic product over three decades. But it may now be time to back off a bit: Investment flows into China seem to be tapering off, going instead into areas in Asia where growth appears to be picking up.

Macro Outlook

China's interest rates have remained steady above 3% since 2010, while the consumer price index and exports have risen on an almost picture-perfect trajectory.

All the while, GDP has continued to grow as government debt came down as a percentage of GDP.

But nothing goes up forever. China is perhaps the strongest economy in the world right now, but every economy cools off and goes through its economic cycles -- and China just reported lower CPI numbers and dented GDP growth, thanks to a decline in net exports caused by both slow U.S. growth and recessionary fears in the eurozone. China may be bracing in for a "new normal," and may have to readjust in light of these numbers.

But, in the meantime, it is important to watch for China inflation, exports, GDP and housing as we attempt to see what kind of a trend they are forging. These charts paint a nice picture of China's economy as of this moment, but if slower growth becomes the new norm -- followed by weaker export demand -- investment flows will divert away from China.

Technicals

While it may look like the macroeconomic outlook it is breaking down, it will take some time to evolve -- assuming it will remain on this path, and that the rest of the world is truly slowing down. Investors have recently been taking money out of China and sending it over to Japan, triggering sharp declines in the iShares FTSE/Xinhua China 25 Index (FXI). Fund managers are getting skeptical of China and other commodity-exporting emerging economies with the so-called death of the commodities super cycle. This is a very bad sign for the Chinese economy.

As we can see above, the FXI is in a bearish zone and will likely remain there -- the price is trading below the cloud on the chart, as the blue lagging line confirms. However, there could very well be some upside volatility, and that looks likely at this point, given the sharpness of the recent decline. Any positive momentum should be looked at as a possible entry point to the downside.

But, regardless of volatility, it is prudent to stay disciplined in case things don't go as according the recent news, flows and price action. Protect your capital via stop losses, pair trades or options; it never hurts to have an insurance policy.

Point and figure fxi

As we can see from the point-and-figure charts, the FXI is just hovering above the $34.75 downward price target, and it should be able to reach that target as long as there is negative flow. If that target is hit, we should then closely watch $31.75 and $30.50. 

The FXI's volatility is already starting to creep higher, meaning that the time window for "cheap protection" is closing fast if you're looking to hedge any bets in the options market via puts.

Conclusion

China's fundamentals have been on an upward trajectory over three decade, but investors should exercise caution regarding the country's long-run prospects. If things turn around down the road -- if the U.S. returns to healthy growth rates and if the eurozone finally gets its monetary house in order -- then things could look better for the Chinese economy. But, given the rate at which cheap money is being poured into the system and the continued slowdown in global growth, that scenario is either a long shot or quite far down the road.

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