Buy Hong Kong, Short Shanghai

06/02/2010 12:00 pm EST

Focus: ETFS

Jim Trippon

Editor-in-Chief, China Stock Digest

James Trippon, editor-in-chief of China Stock Digest, says fear has taken hold of Shanghai’s volatile markets, but he thinks Hong Kong is attractively valued.

Chinese stock markets are dominated by retail investors who bring something of a gambling mentality to the table. The outlook of most investors is short term and that means that China’s markets have always been much more volatile than stock exchanges in more mature economies. Right now, fear is driving Chinese investors.

Beijing says it takes the danger of overheating and a property bubble very seriously, but every time the government clamps down, or even says it might, Chinese stock markets react with fear.

For the near future, it seems that volatility is destined to rule the day. When a market turnaround does occur, as it inevitably will, investors will reap the best rewards.

To profit from this trend, we have bought Inverse ETFs in our model portfolio. Short-selling pressure on Chinese stocks is at a two-year high. My goal is to make a quick gain on the inverse funds within the next three weeks approximately.

ProShares UltraShort FTSE/Xinhua China (NYSEArca: FXP) seeks daily investment results, before fees and expenses, which correspond to 200% of the inverse of the daily performance of the FTSE/Xinhua China 25 index. The fund may employ leveraged investment techniques in seeking its investment objective.

Because the value of the Index is not computed as of the close of the US securities markets—due to differences in trading hours between US and foreign markets—correlation to the Index will be measured by comparing the daily change in the Fund's net asset value per share to the performance of one or more US exchange traded securities or instruments that reflect the values of the securities underlying the index as of the close of the US securities markets.

FXP is added to our buy list at a price of $47.85 per unit. (It closed at about $44 Tuesday. Leveraged inverse short ETFs are for traders or risk-tolerant investors only—Editor.)

The iShares MSCI Hong Kong Index Fund (NYSEArca: EWH) came under heavy pressure as regional risk aversion continued to rise. The prospect of conflict between North and South Korea hasn’t affected the profits of any corporation but it has reduced the valuation of benchmark indexes.

The Hang Seng China Enterprises, for instance, now has a P/E multiple of only 13.4x, compared with 21.5x earnings last December, according to Bloomberg.

In fact, business in Hong Kong is very good. Hong Kong’s economy expanded 8.2% in the first quarter, the fastest pace in four years, as exports and retail spending rebounded from the global crisis. The government maintained a forecast for full-year growth of between 4% and 5% and inflation of 2.3%, adding that the city’s expansion is very likely to be bigger if there are “no major external shocks.”

EWH was added to our buy list at a buy up to price of $15.00 a share. (It closed at around $14.50 Tuesday—Editor.) Our target sell price remains $17.00.

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