You’ve seen this situation before and you know how lucrative it can be.
A country has been through years of economic malaise.
Stocks are way down from past highs.
The country’s central bank, fearful of continued anemic growth, commits to a massive stimulus program.
Despite the flaws of the policy, stocks start going up. They go up some more. And they just keep going up.
Each step higher for stock prices has every investor growing more concerned. Yet stocks keep going up.
That’s exactly what happened in the U.S. over the last six years. The S&P 500 is now up more than 200% and certain sectors like biotech are up ever more. Fortunes have been made.
Now it’s happening all over again in China and there’s still likely time to get in on this one too.
A New Bubble is Here...And I’ve Bought It
China’s facing a very similar situation the United States was just a few years ago.
The country’s GDP growth has slowed to an official rate of 7.7%. That seems good, but it’s not.
China’s GDP growth is well below its pre-2008 heyday when it was in the double digits. And it’s not high enough to keep unemployment low and prosperity spreading.
Worse yet, it’s not going to rebound anytime soon. There are huge economic efficiencies, gross malinvestment, and huge government debt loads to deal with.
These issues have been reflected in the returns of Chinese stocks over the last few years. The large cap Chinese stocks, as represented by the iShares China Large-Cap (FXI), rose 5% between 2010 and the start of this year.
That’s not 5% per year. That’s 5%. Total. For four years.
Meanwhile, the U.S. markets and many other markets around the world were setting new highs.
So China has some problems and it’s stock market was reflecting that.
A few months ago all that changed. Chinese stocks started climbing. They’re up 25% so far this year. And this major breakout has created a great low-risk/high-reward trading opportunity.
The current run in China comes down to not how much Chinese stocks have run recently, but how much potential they have left to run.
That’s where things get really exciting.
For example, the Chinese Large-Cap ETF featured above would have to rise another 40% just to get to their 2007 highs.
That’s exceptional capital appreciation potential compared to the U.S. market.
But there’s an even bigger opportunity here in China’s “A-share” market.
China’s A-share stocks are those which trade directly on the Shanghai Stock Exchange. They are the real runners in this breakout. And they have much more left to run than the large-cap China stocks.
Take a look at the MS China A-share Fund (CAF) to see what I mean.
This fund made up exclusively of A-shares fell much further than the Chinese large cap stocks during the credit crisis. They recovered even slower in the years which followed. And they are now “catching up” to the large-cap Chinese stocks.
Case in point, this fund is up 68% in the last year while Chinese large-cap stocks are up 40%.
But -- and this is the key -- this fund would have to go up 100% to get to it’s past highs.
That’s a huge difference in potential. If Chinese stocks return to past highs, the Chinese large-cap stocks have gained 40% potential gains and Chinese A-shares would have gained 100%
Those types of gains are definitely possible given the amount of stimulus China has committed to get the party started again.
Of course, it takes more than just big potential to make a great trade.
Strategy is just as important. Probably more so.
That’s why we’ve got to recommend a simple strategy to capitalize on this breakout.
Keeping It Simple
In order to capitalize on this China trade, you’ve got to keep a few things in mind throughout it.
Most importantly, you cannot forget this run in Chinese stocks is built on nothing but cheap money and momentum.
These two factors alone will not drive stocks sustainably higher over the long run.
Over the short run, however, these factors can drive these stocks much higher in a very short period of time.
Basically, they’re in what appears to be a late stage bull run.
The chart below, which we’ve used quite a few times in the past, shows the cyclical stages stocks and markets go through:
We’ve gone over in the past the best time for long-term investments to be made is between the “Depression” and “Hope” stages. It’s often the early stages of a multi-year bull run.
Right now, Chinese stocks are at the opposite end of the cycle. They’re likely somewhere between “Optimism” and “Excitement.” So the end may be near, but there’s still a lot of room left to run.
That’s the real opportunity here and there’s a simple and automatic way to go for the ride.
Your editor has bought into this run. I’ve kept a small trailing stop-loss of just 10% to keep the risk/reward deeply tilted in my favor.
Let’s say you bought $1,000 in a popular China ETF which tracks Chinese large-caps stocks or the more volatile A-shares.
As mentioned above, the potential run left to make in Chinese stocks anywhere between 40% and 100%.
Meanwhile, with a small trailing stop-loss of 10%.
So the capital at risk is $100 and the potential gains are anywhere from $100 to $400 to as much as $1,000 if it works out perfectly.
In a market like today’s, there are certainly a lot worse moves than risking $100 to make as much as $1,000 in a few weeks or months time.