For understandable reasons, Chinese stocks have been beaten down for over two years. But things are changing in China, and now there are good reasons to play these former losers again.

Just don’t expect it to be a one-way ticket back to all-time highs. That won’t happen. Instead, you’re going to see a wave of extreme volatility as their chaotic economic conditions keep changing, a yo-yo effect of skyrocketing pops followed by deep pullbacks.

But I always say that if you’re flexible and paying attention, you can make money regardless of what the market does. This situation is no different, and in fact, if you follow the momentum closely, you can play both the upswings and downturns to make gains in both directions.

Here’s everything you need to know: what’s changed in China that makes Chinese stocks worth jumping into again, why it won’t be a one-way ride, and how to position yourself for success as the markets rise and when they inevitably fall.

Why Chinese Stocks Are Pushing Higher
The most apparent change in China causing equities to surge is the Chinese Communist Party (CCP) dismantling the country’s uber-strict zero-Covid policies.

Only two months ago, after the National People’s Congress re-elected Xi Jinping to a third term as China’s president, Xi strongly reiterated his commitment to the zero-Covid policy regime he originated and championed.

But he relented in the face of social unrest. Riots broke out inside Zhengzhou’s giant iPhone manufacturing hub, where over 200,000 people assemble Apple phones, because the workers were locked down without access to medical help. More protests in big cities followed, and finally, ten people died during a blaze in a locked-down residence in Xinjiang .

In early November, China announced 20 key parameters to guide officials in easing the country’s burdensome zero-Covid policy apparatus. They included: cutting isolation for close contacts of infected people to five days at a central facility and three days at home as opposed to seven days in a facility; removing mass testing in most areas; scrapping circuit breaker bans for incoming flights and reducing pre-flight PCR testing to one test from two; and implementing pandemic control measures in industrial parks to ensure smooth supply chain operations .

Riots in Zhengzhou proved new controls in industrial parks an instant bust.

Last week the State Council announced it was going to revisit the country’s Covid policies and practices.

This week, in typical CCP fashion, they passed the blame to local governments as a response to public’s “strong reaction” to the failure of officials “to properly implement earlier directives aimed at easing the burden of pandemic controls on people’s lives.” Li Bin, deputy director of China’s National Health Commission, announced a slew of policy changes:

  • New State Council rules curtailing the power of local authorities to shut down entire city blocks
  • Allowing Covid patients with mild conditions or who are asymptomatic and their close contacts to isolate at home instead of in quarantine facilities (which are supposedly being dismantled)
  • Eliminating “high risk” designation zones and testing and scanning health QR code requirements when entering all buildings except nursing homes and schools
  • Not requiring a negative virus test or checking health codes when arriving in other provinces

Most importantly, and evidence of passing the buck, new rules bar officials from arbitrarily locking down and shutting businesses or restricting residents from going about their daily lives. They also ban hospitals from turning away patients without negative tests if they require urgent care.

Beaten-down Chinese stocks started percolating in November with the country’s new 20-point directives, evidence that zero-Covid policies were under attack. And they’ve skyrocketed since.

But it’s not just dismantling zero-Covid policies that is giving a lift to Chinese shares.

In the U.S., where a fight over delisting Chinese ADRs was a severe worry for any investor wading in the shallow waters of knocked-down shares, signs of Chinese accommodation on providing audited financials for their listed companies was welcome news.

The other underlying push Chinese stocks are enjoying comes from looser financial conditions. The People’s Bank of China lowered interest rates, injected rounds of liquidity into the country’s financial systems and economy, and set aside strict rules enacted in late 2019 to hold wavering property developers and LGFVs (local government financing vehicles) to stricter borrowing and lending standards.

But let’s be clear: this spending isn’t happening because everything’s hunky-dory in China.

Quite the opposite. China’s economy is on the verge of imploding. The amount of leverage in the country’s economy, in every business, in households, on local government’s balance sheets (and more frightening, in off-balance sheet vehicles), and at all the country’s banks is so enormous that any further tightening could trigger a wave of defaults and an economic meltdown.

To prevent what’s still out there and avoid a “Lehman Moment” that could throw the country (and, in fact, the world) into a depression, China’s had to reverse course on its zero-Covid policies and belt-tightening across leveraged institutions.

And that means more profit opportunities for us.

How Exactly to Play Chinese Stocks Right Now
So, in general, it’s safe to play Chinese stocks to the upside. ETFs like KraneShares CSI China Internet ETF (KWEB) and Invesco China Technology ETF (CQQQ) give you broad exposure to the space.

The whole sector has risen from the dead and could go a lot higher… but there are some big “ifs” involved.

As in, if the economy can recover its footing, if factories re-open, if supply chains flow again, and if the rest of the world doesn’t fall into a deep recession that would be a death knell for China.

Those are big “ifs.” And there’s one more.

China’s dismantling its zero-Covid regime will prove to be a trial by fire. Most Chinese aren’t vaccinated. There is no MRNA vaccine in China. Those vaccines are Western, and China’s leadership doesn’t want Western medicines in the country proving their treatments are ineffective. Because so few Chinese are vaccinated, and because, according to Chinese data, they have relatively few infections and deaths given the immense population, the Chinese people haven’t had any opportunity to build up any natural immunities.

So there’s a chance that re-opening China could usher in untold infections and millions of deaths.

That’s why you shouldn’t “invest” in Chinese stocks, per se. Just “trade” them. I like buying big-name tech stocks, like Alibaba Group Holding Ltd (BABA) and Baidu Inc (BIDU), on pullbacks, but I don’t chase skyrocketing stocks and buy them on their highs.

Because they will be so volatile, it makes sense always to use trailing stops if your long positions go up. And it’s a good idea to take profits on rising positions and re-enter them when they slip backward, which they all will eventually.

While you’re at it, why not play pullbacks by buying put option spreads on highfliers destined to come back to earth?

That’s how I’m playing the new interest in Chinese stocks.

— Shah Gilani

Source: Total Wealth