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Bracing for Downside in Big China ETFs

Chinese stocks have been laggards this year compared to the broader emerging markets complex and within the BRIC quartet, only Russia is keeping China from the dubious fourth and last spot.

Yes, the iShares China Large-Cap ETF (FXI) is up about 1% year-to-date while the Market Vectors Russia ETF (RSX) is still in the red. And yes, FXI, the largest China is up 11.3% over the past three months. But even over that time frame, FXI has been the laggard among the major BRIC single-country ETFs.

RSX has been nearly twice as good as FXI over the past 90 days while the WisdomTree India Earnings Fund (EPI) and the iShares MSCI Brazil Capped ETF (EWZ) are up 28% and 25.3%, respectively. [World Cup Rally for Brazil ETFs]

Since the start of the second quarter, FXI has bled $494 million in assets after it was one of the 10 worst ETFs in terms of 2013 outflows. EPI, EWZ and RSX have pulled in $766 million in news assets since the start of the current quarter. [India ETFs See Big Inflows]

Although Chinese stocks are inexpensive, there are potentially discouraging technical signs that must be acknowledged.

“The Shanghai Index looks to be creating a multi-year descending triangle pattern. A little over 50% of the time the asset that forms this pattern, ends up falling in price. When support breaks, over 75% of the time a meaningful decline takes place,” said Chris Kimble of Kimble Charting Solutions.

Kimble adds that if the Shanghai Composite does violate support, the subsequent decline could be as much as 30% or more.

There is anecdotal evidence that some traders are preparing for a decline in Chinese stocks. Year-to-date, the ProShares UltraShort FTSE/Xinhua China 25 (FXP) and the Direxion Daily FTSE China Bear 3X Shares (YANG) have combined to add almost $22 million in assets.

Although has recently been light in YANG, the ETF has seen modest creation activity over the past month, according to Direxion data.

“So far the poor performance of the Shanghai index has had little impact on the stock markets around the world, as many are at or near all-time highs. It could pay to keep one eye on what the Shanghai index does in the next few months, in case support would fail to hold,” notes Kimble.

ProShares UltraShort FTSE/Xinhua China 25