Here's Why China ETFs Are Bouncing Back

Don't look now, but Chinese stocks have been rising. The market that set off the August-September tumult in global financial markets is finally seeing some stability after a rough summer.

The benchmark Shanghai Composite Index was last trading near the 3,400 level, up 19 percent from its lows in August. That's a far cry from the heady 5,200 level the index was trading at in June, but at least the worst seems to be over for China's stock market in the short term.

Shanghai Composite Index

Bubble Bursts

From peak to trough, the Shanghai Composite Index fell about 45 percent, and currently stands about 35 percent below its summer highs. Most analysts attributed the sudden sell-off in China shares to a bursting of a bubble.

Stocks had simply run up too far and too fast, and the downturn brought valuations back to more normal levels, they say. From there, analysts are split.

Some suggest that China shares now offer value for long-term investors. Others opine that the worst is still ahead for the notoriously volatile stock market.

Economy The Wild Card

In the end, how China shares perform from here may come down to whether the government is successful in orchestrating a successful transition in the country's economy away from exports and toward consumption.

Earlier this week, the National Bureau of Statistics reported that gross domestic product in China grew by 6.9 percent year-over-year in the third quarter, slightly ahead of economists' estimates but still the slowest pace of growth since the financial crisis.

For the year as a whole, growth is expected to be similar, which would mark the weakest annual GDP expansion in a quarter-century.

Hard-Landing Fears

Still, the fact that China is slowing is nothing new. That's been happening for several years now, with limited impact on any markets outside of commodities. Rather, the spike in fear levels during August and September was caused by the idea that China's economy might face a more significant downturn―a hard landing―and that policymakers were losing control of the situation.

These fears became most pronounced in August after the People's Bank of China unexpectedly devalued the yuan to a four-year low. The move prompted some to speculate that the economy was decelerating faster than expected and that authorities were scrambling to prop up the country's weak manufacturing sector.

Adding fuel to the idea of a hard landing were various actions taken by the government to staunch the bleeding in the stock market, including trading halts, short-selling bans and arrests of financial journalists. Far from stabilizing the situation, these measures simply added to the perception that authorities were losing control.

Sentiment Recovers

In the last few weeks, a sense of confidence in China's economy has returned as the yuan strengthened modestly and global stock markets recovered. Critically, there hasn't been any significant negative news that's come out of China, which has allowed sentiment to recover.

There's been a slow trickle of economic data that points to a gradually slowing economy, but nothing major that points to a hard landing.

"For all the vices associated with command-and-control economies, one of the virtues is the ability to marshal resources where you need them to be," Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds Management, told ETF.com.

"China itself will avoid a hard landing. It has enough different levers that it can pull in order to make sure that it props up economic growth," he said.

ETFs Bounce

Indeed, the market seems to be taking a more sanguine view than it did only a month or two ago.

Exchange-traded funds tied to China are all up big since the August lows. The Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR | D-53), which tracks large-cap China stocks on the mainland exchanges, is up 17.3 percent. In the same period, the Deutsche X-trackers MSCI All China Equity ETF (CN | F-76), which tracks all China shares classes, including those traded in Hong Kong, is up 15.9 percent.

YTD Returns For ASHR, CN

Andres Garcia-Amaya, an emerging markets analyst at JP Morgan Asset Management, rates China as an "overweight" and sees the potential for more upside.

" ... We don't see any structural change to the story, which is China moving from an investment-heavy economy to a consumer-driven economy," Garcia-Amaya said in an interview with ETF.com. "That's going to take years, not quarters, but it's actually a healthier type of growth, although the level might not be as high as it used to be."

In Garcia-Amaya's view, the magnitude of China's slowdown has been exaggerated, presenting a buying opportunity for investors: "In August and September, the hard-landing scenario became the base case for investors."

"So from that perspective, you don't actually need to get good data; you just need to get less bad data for the markets to rally," he added.

Contact Sumit Roy at [email protected].