For many years people have asked me why I don’t own any meaningful positions in equities, calling me too bearish. Well, in all honesty I just have been waiting for a proper long term opportunity. Have I found one now? I think so, but I am not 100% sure. We will find out soon enough. The truth is, I could pretend to tell you I know what is about to happen and that I know what I am talking about, but in reality, market prices will prove me wrong or right in the coming months and quarters.
My new investment is one of the more hated ones out there. As a matter of fact, whenever I write about this country, I get a lot of hate mail in my inbox. I have been accumulating Chinese shares of late and my position is now getting quite substantial. Regular readers would have noticed many posts about China recently, as I have been dropping hints of a possible new bull market for months. Examples can be found here, here, especially here and here.
At present, I have used quite a lot of cash to purchase this theme investment. When I include ETF positions, and other leveraged instruments I am using, I now have as much exposure in this position as I do in Silver. However unlike my strategy in Silver, where I accumulate positions slowly without a stop loss for the long run, I have pretty much opened up a very large China equities position with a tight stop loss. Why did I do this? Let me explain my reasoning.
Chart 1: China H Shares Index is attempting to break out this week…
My execution links to the technical compression at the end of a major triangle or in simple terms a prolonged price consolidation, seen in Chart 1. We are now in the pressure cooker decision point. Personally, I believe that the tape is signalling an upside breakout, which has been in progress as of this past week. However, if I am wrong and prices reverse quickly, dropping below the 200 day moving average and the bottom part of the triangle seen above, my position will automatically close for a loss of a few percentage points on the index.
Chinese H Shares have gone nowhere in the last few years, and trade at the same level as they did in late 2009. Back in those days the S&P 500 was at 1,000 points, while today it is at over 2,000 points. No wonder I believe China could play catch up. As a matter of fact, the whole story is playing out in similar fashion to the late 1990s, where S&P outperformed and China consolidated for years.
Furthermore, it is not a secret that PE valuations are very attractive, especially on relative basis to other developed markets. Moreover, price to book value is at the very low end of the last two-decade range. While it could still get cheaper, the interesting fact is that since 1995 with the PB ratio this low, the index has rallied 88% of the time over the next 12 months, with an average return of 36%.
Chart 2: Chinese stocks have double 5 times in 18 years, every 3.6 years
However, with China also entering the liquidity game with a recent cut in interest rates (and most likely more to come), this index could play catch up to US / Japanese equities which have also benefited from loosened monetary conditions. Take a look at Chart 2 for the moment.
Consider the fact that Chinese equities have doubled (sometimes almost tripled) over a 12 month time frame, five times in the last 18 years. In basic English, Chinese stocks have gone through the roof every 3.6 years in the last two decades. Also notice how the 3 year performance has been just as bad as it was during the late 1990s, before the last great bull market began.
What fascinates me is the fact that throughout 2013 and 2014, pessimism about the Chinese economy kept getting worse (until recently) and yet every China Stock Index refused to make new lows. Therefore, if the technical breakout seen in Chart 1 holds and continues to push higher, there is no reason to doubt that China equities could be starting a new multi-year bull market.
It needs to said that markets don’t guarantee us anything and instead of moving up the way we would like them too, they could just as easily move down and disappoint us, making my whole execution completely wrong. Regardless, wish me good luck, because I am jumping in for a ride on the back of The Red Dragon!