China is back in the headlines.
Over the past month or so, Chinese stocks have been hit by a barrage of negativity.
Some pundits say property developer Evergrande’s looming bust is the pin that will pop the Chinese economic bubble.
Others argue that the government’s crackdown on certain internet, education and gaming companies signals the end of Western investors’ infatuation.
This onslaught of bad news has hit emerging market stocks particularly hard.
With China accounting for more than 33% of the MSCI Emerging Markets Index, the shenanigans are dragging down the entire emerging markets asset class.
I’m not surprised.
Just last month, I warned readers to avoid Chinese stocks.
I argued that the political risk was too high. With the Chinese Communist Party in charge, an anonymous hack could crush any stock or any sector on a pure whim without any concern for investor losses.
Yet, if I put my contrarian hat on… The current washout in Chinese stocks might represent one of the most attractive short-term speculative opportunities around.
Let me explain…
The China Bear Roars
The recent sell-off hit Chinese technology stocks particularly hard.
So look no further than the most popular exchange-traded fund (ETF) in that sector, the KraneShares CSI China Internet ETF (NYSE: KWEB).
It tracks the CSI Overseas China Internet Index, consisting of 52 stocks.
In mid-August, not a single holding was trading above its 50-day moving average. More recently, only two stocks have closed above their 200-day moving averages.
These are among the worst readings in history.
Meanwhile, the drawdowns have been gigantic. Across the index, the average stock is down nearly 60% from its 52-week high.
The only period that (barely) exceeded this rout was the depths of the global financial crisis. Not even last year’s coronavirus crash hit Chinese tech stocks this hard.
A Terrific Contrarian Buy Signal
As the late, great global investor Sir John Templeton observed…
People are always asking me where the outlook is good, but that’s the wrong question. The right question is where is the outlook most miserable?
Anytime there is such a historic washout in stocks, my contrarian instincts kick in.
These instincts prompted me to recommend cruise line, entertainment and airline stocks after the market crash in March 2020.
Even as investors dumped stocks indiscriminately, I was looking to add positions to my “never sell” portfolio… and make bets on the rebound in the world’s most hated stocks and sectors.
Investors who followed my advice reaped big gains.
Fast-forward 18 months, and China has taken on the mantle of world’s most hated market.
Media coverage is almost uniformly negative. As a result, institutional investors are dumping Chinese stocks.
Tell your broker that you are investing in Chinese stocks, and he’ll tell you you’re crazy.
Share buybacks are another one of the best indicators of a stock’s prospects. And we see evidence of that in China right now.
Tencent Holdings (OTC: TCEHY) is one of the country’s leading internet companies. It is the single largest holding in the KraneShares CSI China Internet ETF.
It turns out that Tencent has been buying back its stock almost every day for the last six weeks.
The good news is it has an exceptional record of buying back its stock near the market bottom.
According to SentimenTrader, whenever Tencent bought back 0.025% of shares within a 30-day window, its stock rallied a median of 84% over the next year.
That’s an impressive track record.
Betting on a Rebound
No one can predict what the Chinese government will do to further undermine Chinese stocks.
Nevertheless, Tencent’s buybacks signal we are close to the end.
And keep this in mind…
Stocks tend to snap back like rubber bands once the lousy news subsides. The biggest gains come in the first few days, rewarding investors who took a position early.
Today, Tencent is trading at a 41% discount to its high of $99.40 reached on February 12. That kind of pullback offers plenty of upside on any rebound.
I usually avoid investing in China. But over the short term, betting on a rebound in Chinese tech stocks offers one of the best risk-reward speculations around.