China ETFs Slip on Fears of a Bubble

A slew of somewhat bearish comments have dragged on China ETF performance, but relative momentum has improved thanks to weakness in other markets.

A BNP Paribas analyst said China could be headed into a period similar to the 1980s asset bubble in Japan. The analyst's statements came on the same day that the Chinese banking regulator tightened some banking regulations and denied rumors of increased capital ratios. The comments also come after Stephen Roach of Morgan Stanley and Bill Gross of Pimco have uttered similar statements about a Chinese bubble.

Although bubble talk has picked up recently, China ETFs have been weak since the summer. They started to lose relative momentum in late July. Shortly thereafter, the China ETFs peaked and remained below that level until last week.

Last Tuesday, Claymore/AlphaShares China Small Cap (HAO - commentary - Trade Now) and iShares FTSE/Xinua China 25 (FXI - commentary - Trade Now) reached new highs for 2009, but they then quickly sold off between 3% and 4% by the close on Friday.

In the past month, the best-performing China ETF was HAO, up 2% and only slightly ahead of FXI and other large-cap-dominated China funds. Claymore/AlphaShares China Real Estate (TAO - commentary - Trade Now) underperformed by more than 5%.

That moderate performance was enough to lift HAO and FXI's relative momentum, however. HAO outperformed several stronger country ETFs in the past month, such as Market Vectors Russia (RSX - commentary - Trade Now), Market Vectors Indonesia (IDX - commentary - Trade Now), iShares Turkey (TUR - commentary - Trade Now) and iShares Austria (EWO - commentary - Trade Now). FXI outperformed the listed funds, save IDX.

In October, I warned that Chinese ETFs would be weak due to slowing loan growth. I don't see any reason to become more optimistic with lending standards tightening, but as a relative play, China ETFs have become more attractive now that other markets have weakened.

One possible play here is First Trust ISE Chindia (FNI - commentary - Trade Now). India ETFs have been stronger than China, but the improvement in China ETFs has lifted the momentum of this fund. India and China have the best prospects for GDP growth in 2010 and FNI could be an outperformer heading into the end of this year.

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At the time of publication, Dion owned RSX.

Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.