It’s not just US stocks that have been falling lately. Shares in China, the world’s third largest equity market, have been falling as well. Since late October, the FTSE/Xinhua China 25 Index Fund (FXI) is down a whopping 27.8%. The recent weakness comes after a strong period for Chinese equities, however. Even after the recent decline, the FXI is more than 200% above its levels two years ago. Yet, although the longer-term trend is bullish, the short-term outlook is not as rosy. Consequently, those investors with worries about further weakness in global equities might want to look at bearish trades on the FXI or perhaps bullish trades on the new UltraShort/Xinhua China 25 Proshare fund (FXP).

The FTSE/Xinua China 25 Index fund tumbled 7.7% Tuesday to close at its lowest level since September 17, or approximately four months ago. The FXI is an exchange-traded fund [ETF] that holds the same twenty-five stocks as the FTSE/Xinhua China 25 Index. The companies come from a diverse set of industries including financials, materials, communications, and energy. China Mobile (CHL), Petrochina (PTR), and China Life Insurance (LFC) are among the fund’s top holdings. 

The FXI has entered into a bear market for several reasons. For one, the financials are reeling amid persistent worries about the ongoing problems in the subrime markets and related issues. Financials account for approximately 37% of the fund. Meanwhile, China Mobile has been under pressure. The stock suffered an 8% loss on Tuesday following reports that the company’s talks with Apple Computer (AAPL) about the launch of the iPhone in China have ended. Petrochina and other energy-related names have seen selling pressure lately amid falling crude oil prices. After reaching $100 a barrel in early January, crude has settled back down towards $92.00. Suffice it to say, many of the same worries that have infected the US market are also taking a toll on equities in China.

Figure 1: FTSE/Xinua China 25 Index fund
(click here for larger view)

In fact, there is an interesting correlation between the iShares FTSE/Xinhua China 25 Index Fund and the most actively traded ETF in the United States. Over the past 90 days, the correlation between the FXI and the PowerShares QQQ Trust Series (QQQQ) is 72%. The chart below shows the recent action in both the FXI and the QQQQ. The QQQQ holds the top 100 non-financial stocks from the NASDAQ Stock Market and is dominated by large cap tech names like Microsoft (MSFT), Intel (INTC), and Apple. From late-July to late-December the two funds moved in perfect sync, almost.

If the FXI tends to move in the same manner as the QQQQ, the news is not terribly good for Wednesday’s trading session. Late Tuesday, shares of Intel, the world’s largest chipmaker and currently the seventh largest component of the NASDAQ 100, was trading down 13.4% after releasing earnings that failed to live up to some analyst estimates.  The decline in Intel comes after a grueling session for technology stocks Tuesday, when the NASDAQ 100 Index tumbled 2.8% and to four-month lows. It also sets the stage for another round of selling Wednesday morning.  

Figure 2: FXI and the PowerShares NASDAQ 100 Index Trust (QQQQ).
(click here for larger view)

Given the relatively downward momentum and relatively bleak short-term outlook for the FXI, some defensive minded investors might be looking for ways to protect themselves, or profit from, further weakness. One approach might be to sell short or use bearish options strategies on the FXI. On the other hand, ProShares, a unit of fund manager ProFunds, recently launched a new exchange-traded fund that allows investors to make big wagers against the equity markets in China. The UltraShort/Xinhua China 25 Proshare fund made its debut a few months ago and already has actively traded options. Trading under the symbol FXP, the fund was created to move opposite to the FTSE/Xinhua China 25 Index, but twice as fast. So, if the FXI falls 1.5%, the UltraShort Fund should gain 3%. Consequently, investors looking for a rebound can consider bearish strategies on the new ETF. Or, investors looking for the carnage to continue, can buy shares or create bullish trades on the FXP.

Frederic Ruffy
Senior Writer & Index Strategist
Optionetics.com ~ Your Options Education Site
Visit Fred Ruffy’s Forum