Short Trade Ideas for China if FXI Rallies

07/07/2017 2:57 am EST

Focus: STOCKS

Landon Whaley

Editor, Focus Market Trader

Trade Idea: New short trade ideas can be initiated if FXI rallies to $39.97, or higher. Once you’ve initiated a new short trade, you can use a risk price between $40.37 and $41.23, asserts Landon Whaley.

The iShares China Large Cap ETF (FXI) declined approximately 40 basis points in the week ending July 7.

The latest Chinese data shows an economy that is continuing to cruise along. The latest Caixin manufacturing PMI accelerated to 50.4, which officially signals expansion and is the highest reading since March. On the other side, the service sector activity slipped, pulling the composite PMI down slightly from the prior month.

chart

The problem in China is not the headline economic numbers because they’ve been steady for months now. The problem in China is the significant amount of financial tightening that has occurred so far in 2017.

Behind the scenes, the PBOC has been draining cash from the system and most recently that proactive tightening has accelerated. In fact, as of July 7, the PBOC has drained liquidity for 11 consecutive days, pulling 660B Yuan from the banking system. The PBOC explains their actions by saying there is plenty of liquidity in the banking system if you take into account banks’ reserve requirement payments.

The PBOC can rationalize their behavior all they want, the bottom line is that there is less liquidity in the Chinese economy than this time last year and less cash in the system will adversely impact Chinese equities.

I’ve been waiting and watching with a Neutral bias for three weeks but I’m now switching to a Short bias and sharing a new trade idea.

Trade Idea: New short trade ideas can be initiated if FXI rallies to $39.97, or higher. Once you’ve initiated a new short trade, you can use a risk price between $40.37 and $41.23, depending on how much room you want to give this trade to move around.

The risk price line in the sand is $41.23. If FXI closes above this price for three consecutive days, then my Short thesis has quantitatively been called into question.

From a profit perspective, if this short trade moves in your favor, you should book profits if FXI falls down to the $39.01 to $38.57 area.

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