This market is a ‘bear trap’ so here’s what to buy, strategist says

There will also be the matter of a Federal Reserve policy decision on Wednesday. No change in rates is expected, but traders will be highly sensitive to guidance on the chances of falling borrowing costs in coming months. The Treasury quarterly refunding announcement could also move bond yields.

And dovetailing with that will be the slew of jobs data over the week, culminating Friday with the January nonfarm payrolls report. Meanwhile, geopolitical tensions are increasing.

Good luck to investors tempted to second guess all that. Yet, it may take even braver traders to consider our call of the day from Evercore ISI: buy China.

As many will know, Chinese equities have been having a very hard time in recent years. A week ago Hong Kong’s Hang Seng
HK:HSI
hit a 14-month low and the Shanghai Composite
CN:SHCOMP
touched a near four-year trough as investors worried about the cratering property market, relatively slow economic growth and tensions between Washington and Beijing.

But those indices have shown small indications of a revival since then, after Beijing talked of trying to support market sentiment and the People’s Bank of China said it would boost liquidity by cutting bank’s reserve requirements by 50 basis points in early February.

The strategy team at Evercore, led by Julian Emanuel, reckons the authorities stepped in when the Shanghai Composite breached what they term the “National Fate Line,” and they see a further policy response following the March 5 meeting of the National People’s Congress.

Such moves will be partly designed to lift the nation’s consumer confidence and this delivers Evercore’s first play, buying U.S. stocks with large exposure to China.

For example, companies who derive more than 10% of revenue from China, and for which Evercore has an outperform rating, include Estee Lauder
EL,
+1.66%,
TE Connectivity
TEL,
+0.15%,
and of course, Apple
AAPL,
-0.90%.

But it is equities listed in Hong Kong, or H shares, that has particularly piqued Evercore’s interest, and they suggest playing this through the iShares China Large-Cap exchange traded fund
FXI,
which closely correlates to the Hang Seng.

That’s because mainland China stocks are currently trading at a greater-than-decade high premium to their offshore peers. Evercore notes that the last time the H shares traded at a similar discount in October 2022, the Hang Seng saw a greater than 55% trough to peak rally in less than two months.

Sentiment is thoroughly bearish. Early last week there were 88% of Hang Seng index stocks below their 200 day moving average. These extremes can trigger rapid rebounds

“A shift in sentiment could skew risk-reward positive,” says Evercore, particularly given short positions in the FXI is at all time highs. Such a “bear trap can catalyze rapid upside,” they add.

A bear trap, the opposite of the more commonly used value trap, is a false indication that a security will decline in value.

Beyond the technical factors there are also more fundamental reasons to look at the Hang Seng/FXI. The Hang Seng’s current 12-month forward price/earnings multiple of 8 is near its pandemic and great financial crisis lows. “That equates to a 30%+ discount to average PE over the past 10 years – the steepest discount relative to its own history globally,” the Evercore team write.

Compared to the S&P 500, the Hang Seng’s PE multiple is trading at a record 60% discount to the S&P 500. Even a reversion to a 40% discount would imply 50% relative gains for the Hang Seng, Evercore reckons.

For investors with access to such trades, and the intestinal fortitude, Evercore suggests buying the FXI March 28 calls at a strike price of $23.5. Implied volatility is reasonably priced given event risk, they say.

They also ran a screen on U.S. listed China ADRs, considering stocks with a greater-than $1 billion market cap; those that either trade at a 50% or greater discount to their 10-year average, or are still 50% below pandemic peak; and those expected to grow earnings in both this year and next.

The top 10 on the list by valuation are Alibaba
BABA,
+0.22%,
Baidu
BIDU,
-0.87%,
JD.com
JD,
-0.29%,
Li Auto
LI,
-0.43%,
Trip.com
TCOM,
+0.75%,
ZTO Express
ZTO,
-1.57%,
Vipshop
VIPS,
+0.69%,
Full Truck Alliance
YMM,
-0.89%,
Futu
FUTU,
-0.08%,
and MINISO Group
MNSO,
-2.41%.

Markets

U.S. stock-index futures
ES00,
+0.05%

YM00,
-0.04%

NQ00,
+0.21%
are little changed as benchmark Treasury yields
BX:TMUBMUSD10Y
dip. The dollar
DXY
is up, while oil prices
CL.1,
+0.33%
dip after recent strength and gold
GC00,
+0.43%
trades near $2,030 an ounce.

For more market updates plus actionable trade ideas for stocks, options and crypto, subscribe to MarketDiem by Investor’s Business Daily.

The buzz

Companies reporting results on Monday include SoFi Technologies
SOFI,
-0.39%,
Franklin Templeton
BEN,
+0.40%
and Alliance Resource Partners
ARLP,
-1.69%
before the opening bell rings on Wall Street, followed after the close by Whirlpool
WHR,
+1.48%,
Cleveland-Cliffs
CLF,
+0.05%
and Nucor
NUE,
+0.23%.

There are no notable U.S. economic reports due Monday.

Oil prices
CL.1,
+0.33%

BRN00,
+0.28%
traded near their highest in two months amid fears of supply disruption in the Middle East after Washington vowed to retaliate for a deadly attack on U.S. service personnel.

China property developer Evergrande is to be liquidated after debt talks fail.

Philips
PHIA,
-7.23%

PHG,
-0.83%
said it will halt the sales of new sleep-therapy devices in the U.S., as part of a broader settlement that led the company to take a €363 million ($393 million) provision.

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