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Weary of the Chinese Seesaw? Think Stability

6 August 2015 in Trading Ideas

The extreme volatility exhibited recently by China’s stock market has taken on a more ominous tone, as analysts have said the country’s equities have been demonstrating a pattern resembling the six months leading up to the 1929 stock market crash in the U.S.

Tom DeMark, of DeMark Analytics, also told Bloomberg News that Chinese stocks would decline by about 14 percent over the next three weeks.(1)

If that happens, it would extend the slide of Chinese stocks to 38 percent since June 12. More importantly, the index’s moves since March are tracking those of the Dow Jones Industrial Average in 1929, when the gauge lost as much as 48 percent, DeMark said.

He was not the first analyst to compare China to the 1929 stock market crash in the U.S.(2)

And at this point, it’s probably useful to point out that DeMark made similar statements in February 2014 about the Standard & Poor’s 500, saying that if certain conditions were met, U.S. stocks were at a point that also resembled the time before the 1929 market crash. The index then rallied 8 percent over the next two months. This past week, he said that those conditions didn’t materialize at the time.

Of course, for some pundits, like Bloomberg columnist Matt Levine, DeMark’s previously failed prognostication suggested that his forecast this time was also “nonsense.” Levine cited the notion that the two charts don’t really look alike, and that China’s market “is, you know, structurally different from the U.S., insofar as its market is run by a Communist Party and all.”(3)

To wit, Levine noted that a spokesman for the China Securities Regulatory Commission “said the regulator had received complaints about the selloff on Monday [July 27] and that it would take enforcement action soon against those who engaged in what he said was ‘coordinated stock dumping.’”

Levine also said that Western banks say they are coming under heavy pressure from Chinese officials to refrain from negative comments.

None of which is to deny that trading in Chinese stocks has not been for the faint of heart. After more than doubling in the 10 months through the middle of June 2015, the Shanghai index lost one third of its value in a month. In the wake of China’s attempts to arrest the massive selloff, the market has since gained back 4.5 percent.

There’s also the issue of what sort of impact both the stock volatility—and what looks like the more real problem of a slowing Chinese economy—could do to stocks in the U.S. As CNNMoney reported, China recently announced that its economic growth has fallen to its lowest level since 2009.(4)

Pockets of the U.S. stock market are certainly exposed to China’s troubles. That’s because 40 percent of the revenue generated by S&P 500 companies comes from overseas.

A faster deceleration of growth in China could disproportionately hurt multinational companies. Earlier this month, for example, United Technologies dimmed its 2015 outlook and pinned the blame on China, CNNMoney said. The manufacturer said new equipment orders at its Otis elevator business experienced a 10 percent tumble last quarter in China alone.

Rather than waiting for Chinese stocks to even out—let alone trying to second guess their impact on the equities of U.S. multinationals—some investors are devoting part of their portfolios to potentially less angst-ridden alternatives.

Two motifs—Stable Earnings and Bullet-Proof Balances Sheets—are focused on stocks of companies that have, respectively, low earnings variability and large cash balances.

Over the past 12 months, Stable Earnings has enjoyed more than triple the performance of the S&P 500, and Bullet Proof Balance Sheets has gained twice as much as the benchmark.

The Stable Earnings motif has risen 1.9 percent in the past month and 19.5 percent over the past 12 months, while Bullet-Proof Balance Sheets has gained 4.7 percent in the past month and 12.7 percent in the last 12 months.

At a time of economic flux in both China and Europe, American companies with potentially more stable financials may be worth a look.

(1) Xie, Ye, “Analyst Who Predicted Bottom for Shanghai Stocks Sees Further 14% Plunge,” Bloomberg.com, July 27, 2015.

(2) Diaz, Amanda, “China’s Market Looks Like the Dow in 1929: Top Technician,” CNBC.com, July 13, 2015.

(3) Levine, Matt, “Goldman in Tech and a Crash in China,” Bloomberg.com, July 28, 2015.

(4) Egan, Matt, “China’s economy is getting sick. Will it infect America?” CNNMoney.com, July 26, 2015.