Biding Time ‘til the Pause is Over (FXI, BIDU)

There have been a number of interesting developments over the last few weeks in the global equity arena, and understanding them will better help us to initiate this week’s trade.

But first a little background.

There’s an increasingly nervous feeling pervading global markets in the lead-up to November’s U.S. congressional elections, and until there’s some certainty of what sort of outcomes we’ll have, markets will likely remain jittery.

Because what stocks least like is uncertainty, and trying to figure out what policy changes, if any, will be in the offing once November’s numbers are finally tallied has a number of bourses wondering where they stand.

Questions…

 

Will a flagging president give over the Senate to a motivated Republican Party? And if so, what can be expected on the economic front? On the foreign policy front? Will it encourage or discourage investment?

In accordance with the uncertainty, the action has been almost entirely negative of late, as the following trading range screen clearly shows –

tradingrange

Here’s a snapshot of every major market in the world, and the same motion is in evidence in nearly all of them – a steepening dive toward the drastically oversold.

What normally follows action like this, of course, is a bounce, and no one is disputing that we’re likely to see, at the very least, a dampening of the selling. But whether the coming move higher is a mere short covering bounce in a longer term downtrend is what has many puzzled.

It appears most pundits and analysts remain convinced of the long-awaited-correction hypothesis, a prognosis that has stymied the best names on the street for almost a year now, as markets keep trending higher and short sellers continue to take a bath.

We don’t believe we’ll see a bear market until markets go absolutely atom bomb rabid – and we’re certainly not there yet. But the volatility should remain until November, if not just before.

Look East

You’ll notice that the steepest dives on the chart above belong to China and Japan, among the world’s most powerful economies and sometime rivals over a few rock outcroppings in the Pacific.

A look at the charts for both of these countries reveals that Japan’s drop is but a minor affair relative to the bull market highs she put in only two weeks ago. Chinese stocks, by contrast, topped out in November of 2010 and have yet to recover to that level after years of more or less sideways action.

Take a look at the Shanghai big-cap stocks, as represented by the iShares China Large-Cap ETF (NYSE:FXI), where we find evidence of upcoming bullish activity –

fxi107
Let’s start with what’s most significant.

We say the unfurling of the moving averages that took place in early September is the salient feature of this chart (red box). Don’t underestimate the meaning of such an occurrence. This is the first time since FXI struck its highs in late 2010 that the moving averages have unfurled higher, and we say it bodes very well for both the Shanghai market and the Chinese economy as a whole.

Note, too, that the market topped precisely as the crossover was happening, then subsequently dove some 13%, as if timed for the best possible distractive intent.

sexyhat

Sexy hat…

The next most important feature is also found within the red box. It occurred when the decline from the September highs found solid footing on the long term (41- day, yellow) moving average, which it contacted three trading sessions ago. Subsequent to that, it bounced higher by six percent over two days (in blue circle), a meaningful development, in our view.

Volume figures also support at least an interim bottom for now (black rectangle), with daily averages climbing from 15 million to 20 million shares traded daily as the selloff ensued.

Taken together, our suspicion is that support is solid at the long term MA and that the bottom is now in. And we look to better days for Shanghai in the weeks and months to come.

The Government of China Swings to the Rescue

Centrally planned economies run by cruel dictators also have their advantages. Though they’re inevitably proven woefully inadequate as managers over the long term, in the short run they can often get things right, do it quickly and for the benefit of investors.

We note that the People’s Bank of China (PBOC), in whose hands the power to fiddle with the fortunes of 1.4 billion Chinese has been vested, recently loosened the property ownership laws of that country, making it easier to acquire a second home at preferred rates if the first has already been paid off.

Previously, the government had been drawing a hard line in the real estate market, afraid that rampant speculation would lead to a bubble and crash that could take years for the country to recover from.

But the latest policy measures are a response to a diminution in speculative activity and a slowdown in both home purchases and overall business activity.

And it apparently sent the right message, as the stock market immediately bottomed and began its ascent as the announcement was made.

Drill Deeper

Never satisfied with making a killing when we can precipitate a slaughter, we now look deeper into the big-cap Chinese market in an effort to locate a company that will thrive as the economy picks up.

And we have to look no further than that country’s highly censored internet realm to find Baidu Inc. (NASDAQ:BIDU), China’s GOOGLE, a company with a market cap of $76 billion, trading with a P/E of 39 and no dividend.

As the trading screen below shows, BIDU showed no signs of weakness of late as the broad Shanghai market cratered, maintaining a ‘neutral’ footing all the while.

bespoke

BIDU’s chart also shows a stock that can grapple with broad market volatility, and still maintain a growth trajectory that should outpace Shanghai when the action starts up again.

Here’s BIDU for the last six months –

bidu

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After rising too far too fast, BIDU has been moving in a range for ten weeks, roughly in line with weakness in the broad global equity indexes.

But with the overbought condition now worked off (red lines at bottom), we foresee a move above the upper end of the range at $231, and that’s where we intend to buy a BIDU CALL spread (and sell a PUT).

The Profit Hunter urges you to consider purchasing the BIDU January 230 CALL for $11.15 and simultaneously selling the BIDU December 250 CALL for $3.95 and the October 31st 200 PUT for $3.15. Total debit on the trade is $4.05

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After rising too far too fast, BIDU has been moving in a range for ten weeks, roughly in line with weakness in the broad global equity indexes.

But with the overbought condition now worked off (red lines at bottom), we foresee a move above the upper end of the range at $231, and that’s where we intend to buy a BIDU CALL spread (and sell a PUT).

The Profit Hunter urges you to consider purchasing the BIDU January 230 CALL for $11.15 and simultaneously selling the BIDU December 250 CALL for $3.95 and the October 31st 200 PUT for $3.15. Total debit on the trade is $4.05

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Mind those expiries.

With love of the hunt,

Hugh L’ O’Haynew, Senior Analyst, The Profit Hunter

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