How To Short China’s Stock Market With ETFs

July 09, 2015

The bubble in Chinese stocks is bursting and there is nowhere to go but down. That is the common refrain echoed throughout the financial media in recent weeks, ever since China shares began their sharp decline after peaking in early June.

 

But is the outlook for China really all that bearish? And if so, is there a way to profit from the stock market plunge?

 

P/E Ratio Not High

There has been no shortage of analysts coming out with bearish calls on Chinese stocks this year. That's certainly understandable in light of the massive run-up in equity prices prior to June, which propelled the benchmark Shanghai Composite Index to a year-to-date gain of 60 percent at one point. From its lows in 2014, the index was up an even more massive 160 percent through June 12.

 

Shanghai Stock Exchange Composite Index

Source: Bloomberg
 

While the big increase in prices in such a short period of time doesn't necessarily mean stocks are in a bubble, it's a cause for concern and further analysis.

 

At the heart of any bubble argument is valuation; the Chinese stock market would have to be massively overvalued based on traditional investment metrics to be considered a bubble. In that regard, the bubble argument isn't cut and dried.

 

Based on data from Bloomberg, the Shanghai Composite has a price/earnings ratio of about 18, down from 26 at the June highs. Ironically, that's the same as the P/E ratio for the most popular United States stock index, the S&P 500, and not many people are saying U.S. stocks are in a bubble.

 

‘We Are Still Positive’

That's why some analysts, like Kinger Lau of Goldman Sachs, are actually bullish on China stocks. "Re-rating is not over for China's stock market," Lau told Bloomberg. "We are still positive."

Lau emphasized that Chinese stocks are much cheaper than they were during the last buying frenzy in 2007, when the Shanghai Composite traded at more than 40 times earnings.

 

Furthermore, while it's been unsuccessful thus far, the Chinese government has taken an active role in trying to stem the decline in stocks, going as far as to ban IPOs and force state-run entities to buy up shares.

 

That could ultimately turn the tide; indeed, it's often been a losing proposition to bet against the Chinese government during the past few decades.

 

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