2013 – Chinese year of the bull?

Since the world first entered the Global Financial Crisis, governments and investors worldwide have looked to the emerging economic strength of China to save it from its own ills. For the past decade or so, China’s economic strength has been nothing short of  staggering.

Its stock market, on the other hand, is a completely different story. As the chart below shows, the performance of the Shanghai Composite has been nothing short of atrocious.

Since its peak in 2007 at approximately 6,000 points, following a near 6 fold increase in just two years, the Chinese stock market has been absolutely crushed, not once, but twice.

Chart 1: Shanghai Composite

(Source: Google Finance)

As the above chart shows, the Chinese Shanghai Composite took off in mid-2005, starting from around 1,000 index points to get as high as 6,000 within the next two years. Then it suffered a crash on a scale as severe as any we have witnessed since that period of time, falling approximately 70% in around 12 months between late 2007 and late 2008.

Thereafter it mounted a rally for around 10 months that took the index 85% higher from its lows. But since 2009, Chinese investors, despite the economic strength China has shown during this period, have had to endure a more agonising and slower death by a thousand cuts as the Shanghai Composite has given up most of those gains since that period of time.

In the past few days, however, evidence has started to mount that perhaps the worst of the declines may be behind the Chinese share market and that more positive days could be ahead.

In a Bloomberg article dated 3 November 2012, Tom DeMark, the creator of numerous well known technical indicators, declared that he believed the Shanghai Composite was likely to rally 48% within the next 9 months, as several of his proprietary indicators suggested that selling pressure had been exhausted.

Then another article on Bloomberg, 5 November 2012, highlighted the significant jump in volume as the index rallied 3% on the day.

But that wasn’t the only interest being sparked. In a note to investors on Monday 3 November 2012, Dr Steve Sjuggerud and Brett Eversole from Stansberry & Associates Investment Research advised that Chinese stocks are cheaper today than they were at their bottoms in 2005 and 2007.

According to Dr Sjuggerud and Eversole, the Shanghai Composite Index now trades for the cheapest Price to Earnings ratio and Price to Book ratio they’ve ever seen. According to them the index trades “for just 7.4x forward earnings and 1.1 times forward book value”. These are amazing numbers when compared to 40x earnings at the peak in 2007 and a 15 year average of 30x.

Chart 2: Shanghai Composite P/E & P/B Ratios

(Source: Daily Wealth, Stansberry & Associates)

From a technical view, we’ve also taken notice. With the index forming a leading bear wedge pattern, the technical picture is indicating that a rally could in fact be around the corner for this index with a potential breakout to the upside possibly just around the  corner.

Chart 3: Shanghai Composite Technical View

(Source: Stockcharts.com)

For information on how we plan to play this potential rally, don’t hesitate to contact our office today for a no cost, no obligation consultation.