When I was in high school, I remember reading about China and the Communist Party's "one-child policy." I recall thinking that restricting citizens' rights to procreate was a tyrannical policy.
Well, fast forward more than three decades and we have the first real crack in China's one-child policy, along with several other major social and economic reforms. The latest reform measures in the country come following the first big meeting of the Chinese Communist Party under new President Xi Jinping.
From an economic and an investment standpoint, there are many positive policy change proposals that could be catalysts for the next sustained move higher in Chinese stocks. These include the call for creating a system for insuring bank deposits and for creating a legal pathway for private bankruptcies. The country also plans on easing price controls on essential services such as energy, telecommunications and water.
Perhaps the most important change, at least from a trading perspective, would be the easing of restrictions on offshore securities investments and mergers and acquisitions. The potential for a loosening of regulations for private companies to offer IPOs in the Chinese stock market (a process that currently is very difficult and time consuming) is something many of the traders I've spoken with in recent days are viewing as bullish.
Indeed, the iShares China Large-Cap (NYSE: FXI) has been impressive since the reforms were announced. FXI has jumped more than 8% since Thursday's close, as traders are betting on a continued spike higher in Chinese equities.
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In addition to the rise in China's large-cap segment, we've also seen a big move in stocks pegged to China's domestic market. The Global X China Consumer ETF (CHIQ) holds China-based companies that provide a variety of goods and services to Chinese citizens in sectors such as automotive, health care and food. CHIQ pulled back Tuesday, but it is still up more than 3% since the country's reforms were announced late last week.
For traders, there definitely appears to be a renewed sense of optimism in the air with respect to China. The reforms are driving capital into both FXI and CHIQ, and there appears to be a strong "buy the reforms" mentality amongst the smart money.
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How long this optimism continues to rule the roost is, of course, unknown, but for now, traders are looking at the relative underperformance of Chinese stocks this year as a potential value play going into the final weeks of the year.
Given the more than 25% rise in the S&P 500 index in 2013, traders are aggressively searching for sectors that offer value and that have a greater probability of delivering big gains.
I suspect the latest Chinese reforms are the green light for the sector traders have been waiting for, and as such, I think both FXI and CHIQ make attractive trades over the next several months.
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Recommended Trade Setups:
-- Buy FXI at the market price
-- Set stop-loss at $35.89, approximately 10% below recent prices
-- Set initial price target at $47.85 for a potential 20% gain in four months
-- Buy CHIQ at the market price
-- Set stop-loss at $14.63, approximately 10% below recent prices
-- Set initial price target at $19.50 for a potential 20% gain in four months