How to Play the China Internet Boom with China ETFs

One of the key benefits of exchange-traded funds (ETFs) is that they offer the ability to trade securities and markets from all over the world, in a single brokerage account (and many have options trading available on them, which provides additional flexibility and leverage).

Traditionally, investors have tended to think of international stocks as a whole (for example, non-U.S.), by broad region, or maybe by a few large economies such as Germany, Japan or China.

As an overview, large-cap technology and the tech sector in general has been strong this year. The major U.S. markets are up in 2017 thus far, with quite a bit of divergence between the worst performer Russell 2000 ETF (IWM), up 3%, and the best, Nasdaq 100 ETF (QQQ), up 17%.

However, the best of 2017 ETF performers list is dominated by international ETFs, and this trend shows no sign of letting up.

In 2017, we’re seeing a vast variety of international ETFs that are trouncing the S&P 500 Index (SPY). Additionally, the diversity of these ETFs is clearly showing that global markets are not monolithic beasts or purely regional.

Single-country ETFs from every region in the world are beating the U.S. market this year so far; examples include Spain ETF (EWP), South Korea ETF (EWY), India ETF (EPI) and Argentina ETF (ARGT).  We’ve traded both EWP and EPI successfully for option profits recently in Wyatt Research ETF Sector Alerts.

The variety and non-correlation we’re seeing within international regions and even within single countries is eye-opening.

Let’s delve into one example, which should have some legs going forward: playing internet growth/technology in China through ETFs.

China ETF (FXI) has long been the most well-known and popular way to invest in the world’s most populated country. And FXI is doing well this year, up 11%.

However, there are four China ETFs that are specifically segmented to the certain portions of the Chinese economy or specific sector groups which are trouncing FXI in 2017.

Those are China Internet ETF (KWEB), up 35%, Golden Dragon China ETF (PGJ), up 32%, China Consumer ETF (CHIQ), up 22% and China Real Estate ETF (TAO), up 21%.

Let’s focus on the first three of those China ETFs, which cover technology and growth areas.

While they hold some of the same stocks in their Top 10 holdings, there is variation among these China ETFs.  KWEB and PGJ have six of the same Top 10 portfolio holdings, KWEB and CHIQ have three of 10, and PGJ and CHIQ have four of 10.

There are well-known names like Baidu (BIDU) and Alibaba (BABA) among the holdings, but also many other companies that may not be as known to the average U.S. investor.

Remember, the massive size of China allows for many giant companies to emerge and co-exist, and China has tended to create its own, protected versions of U.S. internet tech businesses.

It should be noted that KWEB and PGJ have tended to move in a very similar pattern in recent years, but this correlation may not continue at such a strong rate in the future as more divergence between the performance of their holdings emerges.

Only two stocks are held by all three ETFs among their top holdings:  JD.com (JD), a Chinese e-commerce company, and CTRIP (CTRP), an internet travel-services company. Sidenote: 21% of JD is owned by Tencent Holdings (more on them below), and 9% of CTRP is owned by Priceline (PCLN).

Meanwhile, the only one of these stocks that is also held by FXI among its top holdings is Tencent Holdings (TCEHY – OTC), which is the top holding at over 10% of total assets.

While Tencent is not a listed ADR for trading on the U.S. exchanges, in my view it is an individual stock definitely worth considering for longer-term tech investors interested in China.It has a vast portfolio of internet and gaming assets, including that it owns 12% of Activision Blizzard (ATVI).

Charting information is a bit spotty on Tencent stock due to it not being listed in the U.S.  (only over-the-counter under TCEHY, which should be available from your broker).  However, it has run up quite a bit, even more than other names listed here (and others such as Amazon (AMZN), so keep that in mind for the shorter-term.

All of the tech and internet-oriented China ETFs discussed in this piece have moved sharply higher since last December, so a short-term pause or minor pullback wouldn’t be surprising; buying a strong momentum name does offer the risk of jumping in around the top, at times.

However, the longer-term multi-year charts are attractive and don’t show we’re already in an over-extended bubble type move, in my analysis.

For example, see the Weekly chart of PGJ below:
PGJ Weekly Chart

CHINA ETFS

You can see on this chart that PGJ has just recently emerged from a three-year trading range, roughly between 27 and 34 (secondary wider range is around 24 to 36).  As a rule of thumb, the longer a range is in place, the longer a breakout move can last. If you estimate on half the length of the range, it may last as long as 1.5 years.

And the price range of around 25% on the trading range from 2014 to 2016 would indicate that it may have 25% upside potential, if not more. Note the strong trend rally in from 2013 to 2014 took the ETF from around 19 to 31 in about a year, which is a gain of 63%.

Bottom line, if you want to participate in the growth/technology/internet aspect of China, there are better ways to play it than through FXI ETF.

China ETFs like KWEB, PGJ and CHIQ offer a basket of varied names with growth potential . . . and remember, the overall volatility and risk from owning a group of names through an ETF is generally less than owning an individual stock.

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Published by Wyatt Investment Research at