How To Short China’s Stock Market With ETFs

July 09, 2015

 

Small-Caps Different

Still, even though the main Shanghai Composite Index doesn't look particularly overvalued at this point, there's nothing to say it can't get cheaper. After all, the index's P/E ratio was less than 10 just a year ago.

 

Moreover, some analysts say that excluding China's cheap financial giants, the market looks much more bubbly. In fact, the CSI 500 Small Cap Index, which excludes those firms, is trading at a much loftier P/E ratio of 48 currently, down from an eye-popping 83 in June.

 

CSI 500 Small Cap Index P/E

Source: Bloomberg

 

It's no wonder then that small-caps, the segment of the market that ran up the most dramatically during the past year (threefold in the one-year period through June 12), are getting hit the hardest.

 

The Deutsche X-trackers Harvest CSI 500 China-A Shares Small Cap ETF (ASHS | D-73) is the worst-performing China exchange-traded fund. with a loss of 52 percent in less than a month. The ETF has essentially given back all of its gains for the year, but is still up 37 percent from a year ago.

 

For investors looking for bubbles in China, the small-cap arena is where to look.

 

Shorting The Market

That said, is there still a case to be made to short China stocks? To be sure, the Chinese economy continues to face head winds. Economic growth is projected to be around 7 percent this year, which would be the slowest pace in more than two decades. Additionally, there are all sorts of concerns about the health of China's real estate market and the "shadow banking" sector.

 

On a pure valuation basis, small-cap Chinese stocks still look expensive, while large-caps look more reasonably priced. In any case, in the near term, China stocks are likely to move together directionally regardless of individual valuations, as momentum trading rules the day.

 

If stocks decline to just where they were last year, that could entail losses of more than 30 to 40 percent for a small-cap ETF like ASHS or its larger-cap counterpart, the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR | C-60).

 

Outright shorting of those ETFs may be a possibility if shares are available to borrow. However, some traders may find it easier to buy one of the handful of inverse China products that are out there.

 

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