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Mish’s market update: Is China a sleeping giant?

Over 200 years ago, Napoleon Bonaparte pointed at China on a map and said: "There, is a sleeping giant. Let her sleep. For when she wakes, she will shake the world."  

Napoleon’s words appear prophetic as China, particularly in the last 20 years, has woken up. The question is, has China, given some setbacks over the last couple of years, finally put all that behind them? And, can China now start to outperform the US from an investing standpoint? More specifically, could it be time to ‘buy’ the China ETF while the US continues to face its own headwinds?

In early 2021, the People’s Bank of China (PBOC) went hawkish long before the US Federal Reserve did. This puts China well ahead of the US in terms of its position in the monetary cycle. The US finally tightened this past week by raising rates 0.50%. Historically and interestingly, the last time the FOMC hiked the Fed Funds rate by 0.50% was in May 2000, in the early stages of the dot-com bust, and a market correction that saw the US market crash 50% off of its peak by the late autumn of that year.

SPDR S&P 500 ETF Trust chart

The chart shows the S&P 500 from 1998 through to 2007, including the market crash from 2000 to the lows in 2002.

During the 2007-2008 financial crisis, China took aggressive action in November 2007 when its state council unveiled a CNY4 0tn ($585bn) stimulus package. During the crisis in the US that fuelled the unravelling of its markets, the S&P did not hit its nadir until early March 2009. In contrast, the China iShares large-cap ETF (FXI) had already hit its nadir in October 2008 and began a huge rally until its peak in February 2021. With hindsight, going long on the China FXI ETF and shorting the SPDR S&P 500 ETF would have worked out well for traders.

SPDR S&P 500 ETF vs iShares China Large-Cap ETF chart

China exited the financial crisis in good shape, with GDP growing above 9%, coupled with low inflation and a sound fiscal position. Can one surmise the US is this time similarly behind the curve on monetary policy compared to China?

Fast forward to today. China posted better-than-expected GDP growth in the first quarter, though retail sales for March slumped amid ongoing Covid lockdowns on the mainland.

Overall, China and the PBOC are becoming more dovish, just as the US finally started to employ quantitative tightening. The PBOC is keeping its benchmark lending rate unchanged. Analysts are also expecting a cut in the loan prime rate this month.

Additionally, President Xi is preparing to hit pause on its months-long campaign against technology companies. Some believe that China’s regulatory crackdown gave it an economic advantage over the US (who has struggled to regulate its tech giants). However, the results for the Chinese stock market, and specifically for companies like Baidu and Alibaba, were devastating. Now, in the face of Covid and a flagging economy, regulators may promise to no longer levy unexpected huge fines on internet companies or demand sweeping corporate restructuring.

iShares China Large-Cap (FXI) ETF chart

The chart shows the FXI ETF over the last year.

Looking at the recent price action, FXI failed to clear its 50-daily moving average (blue line). If the price does clear above the moving average, this would affirm that the recent lows at 26.13 is the tradeable bottom.

Moreover, FXI is already outperforming the SPDR ETF, as evidenced by our leadership indicator. Lastly, our real motion indicator shows rising momentum, with the move hovering around the 50-day moving average (blue line).

We may have another unusual situation at hand like as illustrated previously back in 2008-2009. China could be at its nadir once again. The US though, struggling with rising inflation, slowing economic growth, price to earnings, and debt at unprecedented highs, may still have more pain ahead.

Read more of Mish's market analysis or visit marketgauge.com.

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