U.S.-China trade talks have been at the forefront of investors’ minds as equities marched higher on speculation that the two countries are getting closer to a truce. The Chinese ETF (FXI) has fared much better than SPDR S&P 500 ETF (SPY) since Oct. 18, 2018; outgaining it 16.8% to 1.7% as of this writing.

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Even though FXI is still lagging SPY by 11% on a trailing year basis, is the recent relative outperformance a reason to buy Chinese equities instead?  Especially since FXI recently touched its three standard deviation upper Bollinger Band, a sign of extreme strength.

FXI performance since inception

In October 2004, iShares launched the Chinese Large-Cap ETF known as FXI to a fanfare of investors wanting to invest in China. Leading up to the launch, the Chinese economy expanded at a rate of 10% a year, far exceeding 2.5% for the United States. China’s rapid economic expansion attracted investors at an alarming rate which led to FXI appreciating more than 320% in three years.  Since FXI’s inception, its overall performance held a slight edge versus SPY (236.4% vs. 231.7%) but with much greater volatility.

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As shown in Table 1 (below), there is only 0.1% difference between FXI and SPY’s annualized return with the former having a 17.5% higher maximum drawdown and almost twice as much volatility than SPY.  These statistics suggest that FXI has not been a good alternate investment vehicle to SPY.  When adjusted for risk, the returns are 4.8% vs. 8.7% respectively. 

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FXI has recently touched its three standard deviation upper Bollinger Band. This widely used indicator incorporates the moving average of the underlying investment with its recent volatility. The upper and lower bands are set at a multiple of standard deviation based on the selected period. For instance, I charted a Bollinger band with a 20-day period and three standard deviations (see chart below).

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Data outside the upper or the lower Bollinger bands are very unlikely events, as there is only a 0.16% chance of closing outside either band.  Although FXI did not close above the band, it peaked above during trading hours. These findings warranted further analysis as to its significance. Does this mean you should chase the Chinese stock rally?

This the only the 20th occurrence of FXI touching the upper Bollinger Band since its inception in 2004.  I calculated the ETF’s performances following this unlikely event over one-day, one-week, one-month, three-month and one-year and compared them to SPY’s return for the same period.  FXI, on average, saw no gains for the first three periods but saw gains of 2.1% and 11.6% after three months and one year respectively (Table 2).  However, the Chinese ETF lagged SPY during all five periods tested.

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Conclusion

As investors try to decipher whether global recession is in the cards in 2019, Chinese stocks have performed well (compared to SPY) since last October.  This outperformance may have peaked as FXI recently touched its three standard deviation Bollinger Band. History suggests that FXI is likely to slightly underperform SPY for the upcoming year; probably with more volatility.  Therefore, I do not recommend investing in FXI as an alternate to SPY.