Fundamentally the case for Chinese stocks is as good as has been in years as not only have they been the best-performing asset class over the past 12 months but the Shanghai Composite is trading well below its record 2007 high leaving it a lot of room higher before finding major resistance. To make the fundamental argument more compelling, China’s nominal GDP has more than doubled since then. Additionally, Chinese GDP relative to world GDP is approximately 14%, while the Chinese market cap relative to world market cap is only 9%. In comparison US GDP relative to world GDP is 27%, while the US market cap relative to world market cap is 37%. Of course, we know the stock market is not the economy but it supports the underlying upside potential. Adding to the fact the number of new Chinese equity trading accounts are surging (adding ~4 million just in March) bringing in a new supply of buyers to their stock market and the promise of monetary stimulus by the Government, the story becomes even more persuasive and as such has my eye.
Fundamentals are good as long-term windsocks, I find when they are used in conjunction with technical analysis the combination provides a great investing mix. The chart below is an 11 year look at the performance ratio of the US total stock market index to that of the Chinese Shanghai index. Starting at the left side of the chart you can see the ratio peaked in 2005 and began to fall eventually finding a bottom in 2008 some 150% lower (meaning the Chinese stock market outperformed the US market during this time period by 150%). The ratio formed a head and shoulders topping pattern in 2006 which provided a downside target (marked by red horizontal line) some 80% lower. The pattern’s target turned out to be incredibly accurate as it eventually bottomed just a few percentage points lower than its objective. Since forming a double bottom in 2009, the roles reversed and US stocks roared back outperforming their Chinese brethren by more than 150% over the next 5 years, topping out in mid-2014 at almost the exact same ratio level as it did in 2005. Like the past top, this one is following the same decline and creating the same head and shoulders topping pattern at the same place and providing the same target. I have to say this chart’s symmetry is a thing of beauty and helps to illustrate that markets do repeat the same patterns over and over. While they don’t all work out this nicely when they do it helps reinforce the value technical analysis brings to the investors toolbox.
I wrote about the breakout in China here back in January some 30+% lower than where we are today. So now what? Is it too late? Based upon the evidence above I expect the Shanghai market to continue its outperformance against the US total market index for another 15-18 months where it will likely reach its projected target. What happens after that is anybody’s guess but what it is telling us is it’s not too late to jump into the Chinese stock market if you are not already exposed. The potential for an upside of 50% against the US markets is just too compelling to ignore.