3 reasons Chinese stocks are resurgent

Don't look now, but the Middle Kingdom is hot again.

Two big, related themes have captured Wall Street's attention over the past year. The meltdown in commodity prices and the meltdown in Chinese stocks. The catalyst for both: A slowdown in China's economic vitality. Other trends include the dollar's rise, a shale oil-OPEC price war and the looming Federal Reserve rate hike.

But change is afoot in China. The Shanghai Stock Exchange Index broke up and out of a downtrend pattern going back to June on Thursday as it pushed to levels not seen since August, as shown in the chart below.

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Stimulus saves the day

The Shanghai index had dropped hard -- down 45% -- between June and its low in late August. Also, at the beginning of August, Beijing devalued its currency by around 2 percent in what authorities claim was an effort to more closely align the official exchange rate with where markets were trading. Many claimed this was another example of China's currency-manipulation strategy to boost exports.

The scary decline was halted on Aug. 25 when the People's Bank of China cut its policy interest rate by 0.25 percent to 4.6 percent. That kept the Shanghai Composite in a trading range near 3,100 for a month.

Shares then started rising as expectations grew for another interest rate cut, which happened late last month, as the PBOC took its policy lending rate down to 4.35 percent. As a result, Danske Bank noted that credit is growing at its fastest rate in four years if bond issuances are included.

And finally, fiscal policy has also turned stimulative as state spending ramps up. According to a fiscal impact measure calculated by the Brookings Institution, things are ramping up: The measure is up 11.8 percent in June, 13.4 percent in July, 14.8 percent in August and 16.4 percent in September.

Compare this to the official spending data showing a 19.9 percent decline in January, which explains the activity slowdown seen earlier in the year.

Economic data is picking up

Also bolstering the bullish case for Chinese stocks has been a turnaround in the hard data.

The Chinese Manufacturing PMI activity index, while remaining in contractionary territory, increased to 48.3 in October vs. 47.2 in September. Any reading under 50 indicates a drop in activity on a month-over-month basis. That was the smallest rate of contraction in four months.

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The chart above shows new order activity on the rise. The Caixin PMI activity index, a private sector measure, showed Chinese factory output enjoyed its largest one-month increase in 15 months in October.

The currency devaluation helped boost September trade data, with balance of trade improving to seven-month highs as the decline in exports narrowed. Imports dropped 17.7 percent from a year ago after falling 14.3 percent in August for the 11th consecutive decline and the steepest fall since May. But in terms of GDP growth, that's a positive.

Consumption is on the rise

In addition, Chinese consumers are perking up. Retail sales in September met expectations and increased 10.9 percent over last year after rising 10.8 percent in August. This is up from a 10 percent rate back in May and returns to growth rates last seen in March. Other anecdotal evidence is improving as well. According to Platts data, China's apparent oil demand rose 2.1 percent in September.

Among additional supportive data: Freight shipments are up 28 percent since June. Property sales rose 23 percent last month from October 2014. Home prices throughout China have been climbing for the past three months.

American investors looking to get exposure to the improvement in China might consider an exchange-traded fund like iShares FTSE China 25 Index Fund (FXI) or, for more company-specific exposure, companies like Caterpillar (CAT) that have been hurt by the recent slowdown.

  • Anthony Mirhaydari

    Anthony Mirhaydari is founder of the Edge , an investment advisory newsletter, and Edge Pro, options newsletter. Previously, he was a markets columnist for MSN Money; a senior research analyst with Markman Capital Insight, a money management firm; and an analyst with Moss Adams focusing on the financial services industry.