Street Smart Eyes US and China

08/04/2014 10:00 am EST

Focus: GLOBAL

Sy Harding—the current #1-rated Long-Term Market Timer according to Timer Digest—remains cautious on US stocks; at the same time, his timing model has issued a buy signal for China. Here, the editor of Street Smart Report shares his current thinking.

Steven Halpern:  Our guest today is market timing expert Sy Harding, editor of Street Smart Report.  How are you doing today, Sy?

Sy Harding:  Well, I’m doing just fine Steven, how are you?

Steven Halpern:  Very good.  Today we’re going to discuss your outlook on China, but before we turn to that market, I was hoping you could summarize your current outlook for US stocks.  I know you’ve been warning investors they’re now becoming too complacent in the past month or two, and about rising risks on the downside; maybe you could update people on your current outlook.

Sy Harding:  Sure.  Well, my forecast since last winter has been for a significant correction in the US market and it’s usually unfavorable summer season this year and I’m expecting a decline of 15%-to-20% for the S&P 500 and 20%-to-25% for the NASDAQ and the Russell 2000 and that they would reach important lows in the October-November timeframe.

But in February it seemed like conditions were setting up early for that correction when my technical indicators began to deteriorate, so we came off our buy signal of last fall in February but only to neutral; however, that was enough to have me lighten up on position. 

We remained cautious and in a neutral outlook since February even as the market remained resilient and rallied to fraction a new high in spite of what, I believe, has been worsening conditions. 

Those conditions—usually seen at market tops—include high market valuations, high levels of investor foolishness and complacency, record margin debt, heavy insider and institutional selling, signs of a potentially slowing economy led by the housing industry, the Fed tapering back stimulus, copy European markets, unfavorable seasonality, and the unusual long time without a normal 10% to 20% correction. 

At this point, my technical indicators remain neutral but they have weakened further and we have been watching closely for a potential outright sell signal, at which time we will be taking downside positions in short sales and inverse ETFs, and the market is down quite sharply today so that will be moving—that loss of momentum will be moving us closer to an outright sell signal if it doesn’t already do so. 

Most of our signals take place as of closing prices so we don’t know if the downturn today will hold until the close.  That’s my outlook for the US market.  I have been and still expect a significant correction to a low in October or November. 

Steven Halpern:  Very interesting.  Despite the negative outlook for the US market your timing system recently issued a buy signal for China, a contrarian position given how negative the sentiment has been on China’s growth prospects.  What’s behind the general skepticism over the China market?

Sy Harding:  Well, for some time, actually several years, investor concerns have been that potential twin bubble in China’s real estate market, and in its credit structure, would result in a hard landing for its economy.  Those concerns have had China’s stock market in a bear market for five years now. 

Investor sentiment is always very high at market tops and very pessimistic and fearful at market lows, so sentiment for China’s economy and stock market understandably reach very pessimistic levels as its bear market continued.

And investor sentiment remains negative in spite of aggressive moves by China’s government to protect and re-stimulate its economy and impressive economic reports in recent months that indicate the moves are working.

Steven Halpern:  So, unlike the US, which is trading at historically high valuations the Shanghai composite is at lower valuations, is that the situation you see right now?

Sy Harding:  Yes, and that’s one of the positives we like about China’s market.  In its five-year bear market China’s stock market declined 65% from its peak in 2007 and 39% from its peak in 2009.  As a result, the Shanghai composite is selling at just 7.9 times its 12 month projected earnings. 

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Meanwhile, the fears that China’s overheated economy would slow dramatically into a hard landing have greatly diminished.  Its economy has slowed only from the unsustainable double-digit growth of 12% a few years ago to 7.5% this year. 

Last week, the International Monetary Fund forecast China’s 2014 economic growth will be at 7.4%.  At the same time, the IMF cut its forecast for 2014 growth in the US economy to just 1.7%. 

We have some interesting comparisons.  The Chinese economy is projected to grow 7.4% in 2014, but has a stock market plunge to a five-year low and selling at only 7.9 times earnings, while the US economy is projected to slow to 1.7% growth and has its stock market at a five-year high and selling at 18 times projected earnings.

Steven Halpern:  Now, also touching on the contrarian indicator, you note that ETF investors have been pulling funds out of China, while, at the same time, you’ve also pointed to some smart money that is taking a more bullish stance?  Can you expand on that?

Sy Harding:  Well, in a recent column on my Web site, which I titled Will Investors Get Out on Time This Time? I included charts from the Investment Company Institute showing how investors held all the way down through the 2007-2009 bear market in the US and only pulled money out after the bear market had ended. 

Studies show that that is a typical pattern to hold through bear markets and then bail out after they end. 

Bloomberg reports that since the new rally began in China at the first of the year investors have pulled $700 million out of US exchange traded funds invested in China’s market.  I believe that may be just another example of investors pulling money out of markets after bear markets have ended and new bull markets have begun.

Steven Halpern:  Yet, there are some investors that you would consider the smart money that are taking the opposite approach.

Sy Harding:  Well, yes, and obviously somebody must be buying to have the China market in such a nice rally.  There are more positive voices showing up lately. 

The current issue of The Economist, for instance, has an interesting article about how Chinese businesses have been slow to embrace the Internet and as they do, productivity should soar.  There are a lot of these positive-sounding articles showing up in the financial press these days replacing some of the really gloomy stuff that was there before. 

Also, for example, Dai Ming at the Hengsheng Hongding Asset Management in Shanghai says there’s a consensus growing that China’s economy can stabilize. 

Peter Sartori, who is the head of San Equities at Nikko Asset in Singapore says, “We have been underweight to Chinese banks for many years.  The time is right to reassess.  China’s banks have stopped underperforming.”

Mark Mobius, who is a well-known chairman of Templeton Emerging Market Group, says the new rally in China is sustainable because of the incredible amount of money available for the market.  Banks are sitting on a lot fuel to add to the fire.  He projects a further gain of 20%.  The sentiment among the smart money people is changing to a more positive outlook.

Steven Halpern:  Now, finally, to benefit from the trends that you’ve discussed, you’ve taking a position in this China focused ETF?  Could you tell our listeners about that fund?

Sy Harding:  Well, yes, we are in the SPDR S&P 500 China ETF (GXC).  It’s designed to track with the S&P/Citigroup/BMI China index. 

It holds stocks of some well know Chinese companies including Baidu (BIDU), China Mobile (CHLKF), CNOOC (CEOHF), and PetroChina (PCCYF), and the ETF has a current dividend yield of about 2.4%.  We think it’s a good holding if we’re correct that the Chinese rally is going to continue.

Steven Halpern:  Well we really appreciate you taking the time today, Thank you so much. 

Sy Harding:  Well, you’re welcome Steve, any time.

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