Trader’s Narrative

The Coppock Curve or Guide is an obscure indicator which tracks the market over a long term time horizon. The indicator is quite simple to calculate but it moves very slowly. What it takes back through lag, it gives multiple fold through an uncanny prescience in determining significant turning points. For more information, check out my original post introducing the Coppock Guide.

Although originally created to track the US stock market, it can in effect be applied to any index. In fact last month, the Coppock Curve turned positive for the Chinese market. I’m relying on the slightly modified IC/Coppock Curve. Since they don’t exactly detail how their calculation is different than the traditional, I’ve contacted them to inquire. When I hear back I’ll update this.

As you can see from the Shanghai stock exchange index, that was quite a while after it actually bottomed. This the inherent disadvantage of such a long term indicator. But if you were a long time reader you would have caught what I wrote in early November 2008: Time to Consider Chinese Stocks. That’s almost to the day when the Chinese market bottomed. Lots of contrarian sentiment, a little dash of technical analysis and a pinch of luck

Since the day I suggested the long side of the Chinese market, the Shanghai index has appreciated by 53%. The numerous ETFs and securities I mentioned have also gone up - the ones that haven’t, bottomed in late rather than early November 2008:

• Morgan Stanley’s China A-Share Fund (CAF) — 80%
• Taiwan Greater China Fund (TFC) — 5%
• The Greater China Fund Inc. (GCH) — 15%
• China Fund Inc. (CHN) — 21.5%
• JF China Region Fund Inc. (JFC) — 10%
• SPDR S&P China ETF (GXC) — 27%
• iShares FTSE/Xinhua China 25 Index (FXI) — 29%

The plus side to this is that if this is a true Coppock signal (that is not a false one) then we are in for another bull market in Shanghai which could last well into next year and take us back up to at least the mid-point of the two extremes - that is to the 3,800-4,000 level.

Also notice how the March 2009 swing low on the Shanghai index is higher than the October/November 2008 lows. And again, in early January 2009, when the S&P 500 was topping, Chinese equities were carving out another swing low. What we have here is higher lows, higher highs. In other words, a confirmed uptrend. And finally, the medium term (50 day - red line) moving average has turned up in support of price with the long term (150 day - blue line) moving average flattening. If this is what it looks like to be, then a pull back would present another opportunity to get on board a long term ride higher.

If you missed the China call and you’re kicking youself, do yourself a favor and grab my feed if you haven’t already and don’t overlook this next opportunity:

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While the Chinese stock market bubble was brewing, a lot of people ignored it and frothed at the mouth about the over-valuation in the US market.

In keeping with that odd behaviour, while the US market has now fallen less than half the distance of the Chinese market (from their respective October 2007 tops), most people are more concerned about the US markets and again are ignoring the very real and brutal bear market in China.

Part of the explanation is that the US markets are obviously much larger and have more significance on the world stage but still, a bear market is a bear market. And over in China they are grappling with a big one.

Bubble, Bubble, Toil & Trouble
The Chinese stock market has gone through bubbles before. This time it only multiplied by a factor of 6 in less than 2 years!

But tha’s nothing compared to 1991 when it multiplied by ten in about a year. Remarkably this recent mania was so strong that it shrugged off a trading stamp tax increase last summer and continued to rally for a few months. Usually such state manipulation would have meant a quick death to the mania.

Click To Enlarge Graph:
To the left is a graph showing the S&P 500 and the Shanghai Index since March 2003, the bottom of the last bear market.

Since the bull market in Chinese shares lasted longer than most predicted, it is safe to say that the bear may last longer also. The next level of support is around the 3000 level. After that, the resistance levels from 2000-2001 will come into play at the 2000 price levels.

Probably the best timer of Chinese stocks has been the editor of the newsletter, Cabot China & Emerging Markets Report. Their virtuoso performance in BRIC emerging markets brought them the trophy of the best newsletter in 2007. For the record, they turned negative in November 2007 right after the top and are continuing to stay away.

The editor, Paul Goodwin, uses an extremely simple way to enter and exit the market: 50 day and 25 day moving averages of Halter USX China Index (HXC). That’s it. Trading doesn’t have to be complicated.

Chinese ADRs
Although there are quiet a few individual Chinese ADRs trading on US exchanges, the only way that I know to actually trade Chinese equities (the A shares) is through the Morgan Stanley A Shares Fund (CAF). It has fallen from almost $61 in October 2007 to its current price in the low $30’s.

As a trading vehicle it is an imperfect one because it doesn’t track the Shanghai index very well. But unless I’m mistaken, it is the only way to get your hands on those A shares from outside China.

China’s stock market ignored all that talk in the summer about a bubble and continued to climb higher. Even a stamp tax increase imposed at the beginning of June this year didn’t impede its meteoric rise:

Usually the increase in transaction costs have been an effective way for the Chinese government to control rampant speculation in their stock exchange. See a history of previous stamp tax increases and their effect on the Shanghai market.

By reaching 6000 in mid October, the index has now multiplied itself 6 times (off its low in 2005). Yet that is still not as impressive as its last bull market in the early 90’s.

If you’re still holding on to the bearish thesis on China you have a new vehicle with which to short China: the UltraShort FTSE/Xinhua China 25 ProShare (FXP). This new ETF provides you with twice the inverse of the Chinese market. But keep in mind that that is merely its goal. It also comes with a hefty 0.95% MER. And remember, you’re going long to establish a short position!

As well, the UltraShort FTSE/Xinhua China 25 ProShare (FXP) isn’t really exposing you to actual Chinese shares. The only way I know that you can get real Chinese equity exposure through North American exchanges is through Morgan Stanley’s China A-Share Fund (CAF).

The Chinese government is actually taking measures to try and control this crazy market of theirs:

• Widen the trading band of the yuan against the dollar to 0.5%
• Up lending rate to 6.57% & deposit rate 3.06% (now just above inflation)
• Raise reserve requirements by half a percentage point by June 5th 2007
• Allow up to 50% of bank assets to be invested internationally

All of these measures are meant to reduce the liquidity sloshing around the Chinese economy (which is finding its way into the stock market). Another positive step they could take would be to allow short-selling but I’m not holding my breath. They already do not allow margin trading so all this mania has been created by fully paid up shares. Can you imagine what it would be like it gamblers, er, I mean investors were allowed to use margin?

To give you an idea of the bubble like action on the Chinese stock market, lets look at it from the point of view of long term moving averages. When the Nasdaq bubble topped on March 10th, 2000, it stood at 5048.62 while its simple 200 day moving average was at 3259.71. In other words, NASDAQ was appx. 54.88% above its long term moving average.

Right now, the Shanghai Composite is around 65% above its 200 day moving average and the Shenzhen Index is 86% above its long term moving average !!

Meanwhile, over in the US, the Dow Jones Industrial is a tame 10% above 200 day moving average and the S&P 500 is around 9% above its MA.

So how can you play this crazy Chinese market?

ok, lets try this again In my last attempt to list the Chinese securities available in the US markets I missed a few…

Thanks to a kind reader, I’ve been reminded of the existence of an exclusive way you can access the otherwise off limits Chinese A-shares. As you know, normally the A-shares are restricted to Chinese nationals but Morgan Stanley has negotiated a small quota of a few hundred million as a Qualified Foreign Institutional Investor and made it available on the NYSE.

An important distinction to note: Morgan Stanley’s China A-Share Fund (CAF) is not an ETF nor does it track an index. It is an actively managed portfolio structured as a closed end fund. And as such it can deviate quite a bit from the Shanghai and Shenzhen indices. It may also trade at premium/discount to its net asset value. And it does.

Right now CAF trades at a discount of 17.35% to its NAV. This is surprising when you consider the scorching performance of the Chinese markets and that this is the exclusive vehicle with which international investors can participate. Perhaps it has to do with the way the fund has lagged the indices:

As the chart shows, CAF has not kept up with the Chinese indices, lagging more than 50% behind the Shenzhen market. Also notice how it took the February 2007 correction much harder than the indices themselves. Unfortunately, “active management” isn’t contributing very much here.

On the plus side, if you’re thinking of shorting CAF, it could fall much faster than the Chinese indices.

Other closed end fund with Chinese exposure are:

• Taiwan Greater China Fund (TFC)
• The Greater China Fund Inc. (GCH)
• China Fund Inc. (CHN)
• JF China Region Fund Inc. (JFC)

and another ETF that I forgot to mention:

• SPDR S&P China ETF (GXC)