Comparison of Shanghai Composite Index, Dow, and VIX The recent happenings in China clearly demonstrate that the Chinese economy and financial market is a disaster waiting to happen. This year, I predict that China will go into a recession after the bubble in its stock market bursts. A bubble is a situation where asset classes rise in prices without no underlying intrinsic value. The mark to market value of these assets is usually not the same. For instance, in 2006 and 2007, in the United States, there was a continued rise in real estate prices as a result of the subprime loans offered by financial institutions. The bubble didn’t last for too long. It led to one of the worst recessions in the recent past with key institutions such as Lehman Brothers filing for bankruptcy. The same is happening in China. For the last decade, the Chinese stock market has had triple digit growth with the increasing economy. However, the real intrinsic value of these companies has remained pretty less than the market prices. The government has pumped billions of dollars with a view of stabilizing the financial market. Recently, they did this by putting a circuit breaker to prevent a fall in prices below 7%. This is financial engineering and not a good way of implementing measures in the 21st century. For traders however, these opportunities create increased volatility which in turn leads to more trading opportunities. In this article, I will explain a number of key sectors to invest in under the current economic environment.
For equity traders, the retail sector is one of the best areas to allocate their capital. The logic behind this is simple. China is trying to contain its currency by making it weaker. A weaker currency favors exports by making goods less expensive. Today, most companies in the United States and Canada outsource production in China. As a result, goods that will come from China will be less expensive than before which will make them more attractive to buyers. With the United States consumer confidence levels being on the rise, chances are that customers will buy more. I believe this is the main reason why Walmart is currently one of the best performing stocks in Year-to-date.
Technology is another key sector that will definitely see increased growth no matter what happens with the Chinese markets. Technology companies such as Apple and Microsoft outsource the production of their hardware devices in China. If China continues to make its currency weaker, the result is that these devices will become relatively cheaper which will lead to more sales. However, traders and investors need to look at these companies carefully to cushion themselves from other factors.
You can never go wrong with currencies. If you are well-trained with fundamental and technical analysis, then you can navigate the complex financial market with currencies. By going short and long currencies in a short timeframe such as a day, you will be able to move regardless of what the Chinese market moves. For instance, if the Chinese market falls, the spill-over to global finance will be tremendous. In such a situation, you can hedge your long positions with short ones and make the differential profits.
A weak Chinese economy leads to reduced prices in commodities in general. This is because China is the largest consumer of commodities. If there is a problem in such a consumer nation, it implies that the prices will ultimately come down. This will be an opportunity to short various commodities such as copper and nickel while going long gold.