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China's Second-Half Rally Is Right On Time

8 August 2014 in Trading Ideas

Many US investors are familiar with the old “Sell in May and go away” adage that suggests that the typical upside in stocks during any calendar year is captured from New Year’s Day to April 30.

As it turns out, Chinese stocks may have a pattern of their own. The Financial Times recently pointed out a pattern, albeit imprecise, that has emerged in equities of that country since the financial crisis. In each of the past four years, the MSCI China index has suffered lengthy first-half declines – from 32% in 2011 to 10% in 2012.1

But rallies have followed during the second half, with typical gains of about 30%.

And look what’s happening this year: After a decline into early May, the index has now climbed more than 12%.

 

Other China-focused investments have also outperformed recently. The Chinese segment of the Asian Fusion motif – a 44.2% weighting in the portfolio – has climbed 8.8% in the past month.

Overall, the entire motif has risen 1.8% in the past month. During that same time period, the S&P 500 has declined 2.8%.

So far this year, the Asian Fusion motif has increased 7.2%; the S&P 500 has returned 5.1%.

As the FT noted, there is some logic to the country’s stock seasonality. The Chinese New Year, when hundreds of millions of workers from cities and factories return home for the holidays, tend to cause a drop in economic activity.

Ending that slump has often required a push in the form of government stimulus or increased lending, which can take a few months to have an impact.

The FT said this year, however, has seen other factors that worked to push Chinese stocks lower in the year’s first half, including a campaign to stamp out corruption that has hurt spending on luxury goods and travel, the first corporate bond default of the modern era, and a slumping property market, which has seen falling sales and profits and slowing construction.

That said, those investing in Chinese stocks have recently been buoyed by signs of a turnaround. Second-quarter growth figures showed that the economy had accelerated slightly, rising 7.5% from a year earlier, above most expectations.

In addition, the most recent housing data also indicated that the slide in prices has slowed in the past few weeks, which could be a sign that the property market is bottoming out.

Of course, a key question for investors now is whether there is upside left after the three-month bounce in Chinese stocks.

For Mark Mobius, who runs the $12 billion Templeton Asian Growth Fund, the answer is yes. He predicts the Chinese stock market will climb another 20%. He favors state-owned banks and energy companies because of their cheap valuations and the government’s plans to open up state-dominated industries.2

“Usually when you enter a phase like this, you’re looking at at least 20% upside,” from current levels, he told Bloomberg BusinessWeek.

Other analysts, like Bank of America’s David Cui, are much more cautious going forward.

Naturally, future evidence on China’s growth prospects could go a long way to determining the direction of the country’s stocks from here.

1Josh Noble, “China’s second-half rally becomes an annual event,” ft.com, July 23, 2014.

2Kana Nishizawa, “Mobius Says Not Too Late to Buy China With 20% Upside,” businessweek.com, July 25, 2014, http://www.businessweek.com/news/2014-07-24/mobius-says-not-too-late-to-buy-china-with-20-percent-upside, (accessed Aug. 6, 2014).

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