Buyer beware this Chinese New Year

Playing the Chinese New Year is a popular story with the money sections of the national newspapers. The stories normally centre around the idea that the Chinese New Year is upon us, so should you be buying Chinese equities? This year the Chinese New Year celebrations start on 19th February 2015.

Where is the evidence?

Yet apart from a sense of euphoria, where is the evidence that buying Chinese equities around the Chinese New Year is profitable? Is it just an assumption drawn from the Santa rally / January effect traders look for in US and UK equity markets?

Let us take the last 5 years for example, below I've mapped how well you would have done in local currency terms if you'd bought Chinese equities (as measured by the MSCI China Index) at the start of the Chinese New Year in each case. Obviously the date of the Chinese New Year varies from year to year which is why each chart starts at a difference date.

 

2010 New Year - 14/02/2010

 

2011 New Year - (03/02/2011)

 

2012 New Year - (23/01/2012)

 

2013 New Year - (10/02/2013)

 

2014 New Year - (31/01/2014)

 

It's not the Chinese New Year you want to worry about

The charts show in reality there is no immediate benefit from investing in Chinese equities around their New Year. In fact, if you avoided an immediate loss then typically within 3 months you will be sitting on a paper loss anyway.

You may suggest that this is a relatively small sample of 5 years, however, there is a reason for choosing it. Since the financial crisis a new pattern has emerged where Chinese equities have tended to slump in the first half of the year and then rallied strongly in the second half (just look at the charts above). In 4 out of the last 5 years a first half-year decline in the MSCI China Index has preceded strong second half-year rallies. In the summer of 2014 I talked pointed out this trend in an article for The Telegraph and lo and behold it materialised that year.

Interestingly, a possible cause may actually be the Chinese New Year itself. With millions of workers heading home for the holiday period economic activity takes a dip. To nudge things along the government will often need to add some form of stimulus. Yet any measures won't have an immediate impact and their stimulating effect can take months to trickle through.

It's all about timing

Assuming a rally does materialise in a given year predicting when it will start is tricky. In 2011 the rally started in October, in 2012 it started in September while last year it began in June (see chart above). Trading short term is all about knowing when to get in and out. The problem is that Chinese equities are volatile and investors can quickly be left sitting on hefty losses.

During a period which saw Chinese equities rally 32%, an investor who bought on the Chinese New Year back in 2011 would be down 7% in sterling terms to date!

Money printing woes

If you look at the chart above for 2011, between the July and the market low of October that year the MSCI China Index suffered its biggest correction and fell over 30%. Which roughly coincided with the end of QE2 in the US and investor risk aversion. In 2014 a 10% correction roughly coincided with the imminent end of QE3.

But then Chinese equities rallied, largely due to government actions, namely a surprise rate cut and the opening of the Hong Kong-Shanghai Stock Connect which opened up the domestic stock market to the world's investors.

So what will happen this Chinese New Year 2015

It is hard to say but we've seen some strong bouts of volatility in Chinese markets in recent months. Plus a lot of the recent rally has been driven by stimulus and the opening up of the Chinese stock market.  Can that rally really continue in the short term? Also, there's concern over Chinese economic growth with the recent news that 2014 was the worst year for economic growth in the last 24.

Yet based on a number of valuation methods, Chinese equities may not be as cheap as they once were but there remains value, hinting at the possibility of double digit returns over the coming years. So to sum up:

• Don't buy Chinese equities because of the New Year
• Often any rally takes place later in the year
• Chinese equities are very volatile (as evidenced by my recent stop loss alert)
• There is value but only those happy investing for the long term should buy

Which China funds might you buy

Investor have limited choice when it comes to investing in China but the stand out funds remain:

Unit trust

Invesco Perpetual Hong Kong China - one of the oldest and largest funds in its sector (at £340m). The fund is one of the top performing China funds over the last 3 years (up nearly 47.99%).  A consistently strong performer that has proved more resilient than many of its peers during market sell-offs, as evidenced by its comparatively low volatility. One to buy and hold.

Investment Trust

Fidelity China Special Situations - not for the faint hearted but if you believe Chinese equities are good value then Fidelity China Special Situations is worth a look. Unlike its unit trust peers the investment trust can borrow to invest (called gearing) which this trust does at over 25% of net assets. This can boost returns but also increases risks to the downside. The trust currently trades at a discount of around 11% to its NAV (net asset value). With its small cap focus and technology exposure this is a high risk play. If Chinese equities take off and the fund can avoid any stock specific hiccups then this trust could surprise to the upside.