The Big Money Is Buying and Selling China

02/23/2009 11:43 am EST

Focus: ETFS

Peter Way

Founder and CIO, Peter Way Associates

Peter F. Way, editor of Block Traders’ ETF Monitor, says big market makers are betting on and against the Chinese market, and he explains why.

When prices drop, usually expectations tend to move more slowly and the space between market prices and their upside potentials widens. That’s healthy. Instead, what we are seeing now is neither the widened uncertainty present last October and November, nor any marked improvement in the upsides of our large equity population.

We cover over 2,000 of the market’s most active and widely held stocks, inferring what big players on the buy side of the street are likely to do to future equity prices. We get those indications from the way the volume market makers protect themselves as they take at-risk positions to provide market liquidity in helping their clients manage investments.

The market’s psychology, at least at the big fund manager level, seems to be at best simply a continuation of depressed levels, and perhaps a retest of the early November fear bottom.

No one really knows, so the best we can do here is try to identify those ETFs that influential investors, by their actions, indicate are the better candidates to live with through the trying times.

SPDR S&P China (NYSEArca: GXC) has a combined Odds and Payoffs of +8%, coming from past experience and a good frequency of gains. It has a history of forging ahead in price even when the outlook is a bit adverse. GXC ranks better than 93% of the over 2300 issues we rate daily.

(Peter Way combines the amount a stock is likely to return and its probability of payoff, based on his analysis of what big players are doing. He views anything above 5% on that scale as positive—Editor.)

There is a puzzling anomaly between GXC, a conventional long-position play on Chinese stocks, and UltraShort FTSE/Xinhua China 25 ProShares (NYSEArca: FXP), a leveraged short, or inverse-action ETF, [because] both appear attractive at the same time

Part of the answer lies in the makeup of the holdings behind the ETFs: FXP is very concentrated, with some 65% of its assets in financials and energy, while GXC is far more diverse, with holdings in consumer goods and services, while FXP has none.

[Also,] these ETFs are not regarded as long-term investments in the way a Bristol-Myers Squibb (NYSE: BMY), Wal-Mart Stores (NYSE: WMT), Intel (Nasdaq: INTC), or other stocks might be.

These two ETFs may be positioned to be like two legs of an option strategy (a straddle) that stands to provide a profit either way the underlying security moves. In a lucky or skillful circumstance, gains may be realized on both legs of the proposition. So, it may not be illogical to hold both at the same time, especially if each is acquired at advantageous prices.

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