The trade idea of the year recently hit the financial media, and it's all about the "China Reopening." For those unaware of the situation across the ocean, the long story short is that the Chinese economy has more or less been on hiatus since the peak of the COVID-19 pandemic.
Chinese equity investors have endured a gauntlet of volatility-inducing negative catalysts over the year, such as contagion in the real estate market due to the Evergrande credit crisis, political crackdowns on the tech sector, and retail closures due to the strict "Zero-COVID" policy.
All that seems to be coming to an end though, with China bulls being unusually optimistic since the start of 2023 for the country's market prospects. Let's take a look at what's driving this optimism and assess which ETFs may be suitable to bet on a potential rebound.
What's going on in China?
According to its National Bureau of Statistics, China's gross domestic product, or GDP expanded by just 3% in 2022, compared to 8.1% in 2021. This fell shy of the government's 5.5% growth target, largely due to weakness in the retail sector as a result of mass lockdowns.
The tone began to change in the first days of 2023, notably when China lifted border restrictions. This action dramatically eased entry for tourists and business travelers alike and has been interpreted so far as a positive sign that China is seeking a return to pre-pandemic conditions.
With China's consumer population once again allowed to travel, the expectation is that this demographic will engage in a high degree of spending, whether on air travel, hotels, or retail, which can invigorate global economies thanks to their large headcount.
However, with the traditional Lunar New Year traveling underway, concerns are afoot that COVID-19 infections in the country may again be on the rise, adding to some uncertainty as to when it comes whether or not the relaxation in restrictions will be merely transient or permanent.
Due to this uncertainty, it can be argued that the Chinese reopening isn't fully "priced in." The situation is still developing, and there is always the possibility that the government will abruptly pivot back to greater restrictions should infection rates worsen.
What ETFs to use?
Investors wishing to take a long position when it comes to China's reopening have a variety of country-specific ETFs at their disposal, which can be broad-based, sector-based, or leveraged/inverse. Each of these ETFs has specific use cases and risks, so discretion is vital.
For a broad-market play, the most popular ETF is the iShares MSCI China ETF (MCHI), which holds roughly 630 Chinese equities weighted by market capitalization.
Many investors like MCHI due to the perceived low valuations of Chinese equities. MCHI currently has a price-to-book ratio of 1.72 and a price-to-earnings ratio of 11.99, far lower than U.S. equity indices. However, it is highly volatile, with an average three-year standard deviation of 29.54%.
For sector plays, investors can consider the KraneShares CSI China Internet ETF (KWEB) and the Global X MSCI China Consumer Discretionary ETF (CHIQ).
The Chinese information technology and consumer discretionary sectors tend to be the most sensitive to economic changes, and arguably have the greatest upside potential in the event of a reopening. Both of these ETFs could be suitable for a concentrated, high-beta bet.
Finally, investors seeking enhanced exposure can also make use of leveraged and inverse ETFs like the Direxion Daily FTSE China Bull 3x Shares (YINN) or the Direxion Daily FTSE China Bear 3x Shares (YANG).
Keep in mind that these ETFs tend to be highly volatile and are intended for short-term trading purposes. Long-term holds of 3x leveraged ETFs can produce unexpected results deviating from their daily leverage targets. They also tend to be fairly expensive in terms of fees.
This content was originally published by our partners at ETF Central.