A Weekend of Triumph for Beijing: Is This China Large-Cap ETF About To Break Out? 9
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Strong Chinese Economic Data and the Yuan’s Initiation Create Positive Sentiment

Today marks the start of the last trading quarter of 2016 and so the chase for yield into year-end begins. From a positioning standpoint, the outperformance of various emerging market asset classes on a year to date (YTD) basis will certainly continue to be on the minds of portfolio managers. Within this context, the last couple of days provided welcome news for the largest emerging market economy, China.

China’s official manufacturing PMI remained in expansion territory, coming in at 50.4. While the September number was unchanged from the previous month, two key points should be noted. First, the last two manufacturing PMI readings printed at the highest level of the past two years, reflecting the increasing confidence of Chinese manufacturing enterprises in a favorable demand/supply situation. Second, when examining monthly manufacturing PMI prints since October 2014, the frequent and erratic swings between contraction/expansion levels should be noted. This picture stands in stark contrast to the recent stable prints. Note that the “50-threshold” that separates expansion from contraction.

China Manufacturing PMI Readings since October 2014

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Arguably even more notable than the apparent stabilization in China’s manufacturing sector is that the region’s services industry is showing continued growth. China’s non-manufacturing PMI rose to 53.7 from a previous reading of 53.5. Additionally, investors may want to focus on an often-forgotten, but important sub-statistic: The non-manufacturing sub-index focusing on new orders increased to 51.4, which is at its highest level of 2016. These developments can be seen in the context of China’s transition towards a service-oriented economy as the chart below powerfully demonstrates:

Growth of the Services Sector to China’s GDP since 2005:

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In addition to the aforementioned positive data points, the IMF’s decision to include the Chinese yuan in its basket of reserve currencies – which became official on Saturday, 1 October – should also contribute to positive investor sentiment. After all, the inclusion marks the end of a long government campaign for recognition as a global economic power.

Cross-Asset Picture Reflects Positive Reaction to Chinese Data:

A quick look across asset classes this morning shows that traders are reacting positively to the weekend developments out of China. While most Chinese markets are closed this week for the National Day holiday, the Hang Seng Index (HSI) traded higher ~1.2% over night, while the Hang Seng China Enterprises Index (HSCEI) gained ~1.0%. The Australian Dollar (AUDUSD) – often used as a measure for Chinese market sentiment as China is Australia’s largest trading partner – has been inching higher since the open of FX trading on Sunday. Commodities, which are closely tied to Chinese economic activity, portray similar strength this morning as crude oil, gold and silver futures all trade in positive territory.

Trade Suggestions: Position for Upside in FXI

Improving Chinese manufacturing and services activity together with the IMF’s acceptance of the Yuan as a reserve currency provides “rocket-fuel” for Chinese equities at the start of the fourth quarter of 2016. PMI data over the weekend showed that the greatest amount of optimism came from large-cap businesses in China. Additionally, the growth in China’s services sector is picking up. Therefore, establishing long positions in a product that combines the large-cap and services-sector aspects is preferable.

The iShares China Large-Cap ETF (FXI) seems suitable. For one, the ETF giant tracks the 50 largest and most liquid Chinese stocks traded on the Hong Kong Stock Exchange. In addition, service companies make up a large percentage of the ETF’s overall weight as financials contribute ~54.4% and telecommunication services make up ~12.6%. Additionally, FXI has “year-end catch-up potential” as it has underperformed emerging market composite ETFs, including iShares MSCI Emerging Markets ETF (EEM) and Vanguard’s FTSE Emerging Markets ETF (VWO) on a YTD basis:

FXI (iShares China Large-Cap ETF) Underperformed EEM and VWO on YTD Basis:

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Finally, considering FXI’s technical set-up, it should be noted that its upward trend is intact and that the ETF is currently in a triangle formation. Given the aforementioned positive tailwinds, an upward breakout of this triangle formation becomes increasingly likely.

FXI (iShares China Large-Cap ETF) About To Break To The Upside?

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