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China ETFs Tumble to Start 2014

Zacks Equity Research

The Chinese financial markets saw a weak start to 2014 following a slowdown in manufacturing and service activities as well as a lack of liquidity. The latest indicators suggest that the world’s second largest economy is losing steam again after showing six months of stability.
The Chinese manufacturing index (PPMIQ) declined to 50.9 in December from 52.5 in November, indicating the lowest level in four months while the service sector index also slipped to the four-month low of 54.6 in December from 56 in November (read: Best ETF Strategies for 2014).
In addition, an official audit report showed that China’s local government debt soared 70% over the past three years to 17.9 trillion yuan ($2.95 trillion) at the end of June 2013. One of the main reasons of growing local government debt is rapidly rising shadow banking.
The local government debt is well below the debt level of many other developed nations like the U.S., U.K., France, Japan, Germany and Spain. However, the pace at which the local debt has risen could be a major drawback to Chinese stability.
Further, China could face another cash crunch at the end of this month as the demand for cash from firms and depositors would increase ahead of the Chinese New Year holiday (see: all the Emerging Asia Pacific ETFs here).
Market Impact
The slew of negative news sent the Chinese stocks and the related ETFs lower in the first few trading sessions of 2014. Large cap focused China ETFs stole the show with the ultra-popular iShares FTSE China 25 Index Fund (FXI) plunging close to 6.1% on the first three trading sessions of 2014.
Other China large cap focused funds – iShares MSCI China Index Fund (MCHI), SPDR S&P China ETF (GXC) and iShares FTSE China ETF (FCHI) – also saw rough trading sessions. MCHI and FCHI are down nearly 5% each while GXC lost 4.5% to start the year.
Global X China Financials ETF (CHIX) has seen horrendous trading over the past three days, losing about 6.7% while China A-Shares ETFs – PEK, CHNA and ASHR – fell 4.6%, 1.5% and 4.7%, respectively (read: China A-Shares ETFs Explained).
What Lies Ahead?
In order to curb financial risk, China is seeking tighter controls on the shadow banking system and has issued new regulations to limit growth on unregulated loans. However, the restrictions on risky lending means less credit in the economy and in turn lower GDP growth.
As such, 2013 GDP growth might fall to less than 7% from the expected 7.6%. This could have serious consequences on the economy and social stability.
In fact, even in the fourth quarter, Reuters estimates the economy to grow 7.6%, down from 7.8% growth in the third quarter. This would drag down full-year GDP growth to the lowest level in 14 years. 
On a positive note, the central bank aims to maintain relatively steady monetary conditions as it pushes financial reforms. The implementation of several social and economic reforms over the next five years will reinvigorate the economy (read: China ETFs Jump on Government Reform Afterglow).
Chinese growth in 2014 would further be supported by improving economic fundamentals in the   developed markets like the U.S. and Europe, which are the two main export destinations of China, as well as higher domestic demand (read: Buy these China ETFs as Outlook Brightens). 
Moreover, China has $3.5 trillion in foreign exchange reserves and double-digit fiscal revenue growth that could cushion against a slowdown, should it happen.
Bottom Line
It seems that the current fundamentals are not working in favor of China growth prospects for the near term but long-term reforms could definitely bear fruit over the course of the year. Further, given the fact that China has abundant resources to fight the broad-based downturn, investors could definitely take the opportunity of beaten down prices and could beef up China ETFs in their portfolio for capital appreciation in the months ahead. 
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