Why Chasing The China Rally Could Cost You Everything

The biggest story of the week has been the moves in China. When the Chinese authorities unveiled the second half of their stimulus plan, it caused a frenzy of activity for their markets, as well as for several other markets in that part of the world. China’s CSI 300 index has rallied almost 16% last week…which helped many of its ADR stocks trading on US exchanges skyrocket higher. 

On a longer-term basis, I agree with those who are skeptical about whether these stimulus programs will do a lot to help the structural problems that have developed in China's economy, especially in their real estate sector. However, on an intermediate-term basis, we know how much massive liquidity injections can help markets for many, many months.

However, this rally won’t last nearly as long.

Here’s why chasing Chinese stocks right now is a bad idea.

All we have to do is go back to the pandemic, when the global economy all but shut down, and yet the huge stimulus and liquidity programs that were established by governments and central banks around the world helped global stock markets bounce strongly from their March 2020 lows.

In the U.S, this rally lasted about 20 months, so there is little question in our minds that these newly announced programs can help their stock market advance for quite some time as well.

Again, since the structural problems are so big in China, this rally will have a tough time lasting as long, or going as far, as the global rally did from March 2020 until late 2021. But it should be able to go on for quite some time.

Having said that, it doesn't mean that it will rally in a straight line. The rally we saw in most markets at the beginning of the stimulus-induced advances in 2020 pale in comparison to what we saw last week in China. In other words, last week's rally in China was even stronger than the one we saw around the globe in 2020. Therefore, China's market, and many of their individual stocks, have become extremely overbought, and they've done so much faster than anything did during the 2020 pandemic. 

Take a look at the three charts I have provided below, of China’s CSI 300 index as well as of two Chinese tech giants. They show RSI charts that are extremely extended and Bollinger Bands charts that are the same. This does not mean that these names will come crashing down to Earth next week.

In fact, I expect China will keep plenty of liquidity available to prevent that from taking place. It would be a big blow to confidence if their markets reversed lower so quickly after their programs were announced.

However, I do expect to see their market to see some sort of pullback soon. Therefore, I believe that it will be a good idea to guard against chasing these names in an aggressive manner over the very-near-term.

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