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HomeMarketChina Could Reignite Its Growth. How to Play It While Limiting Risks.

China Could Reignite Its Growth. How to Play It While Limiting Risks.

A security guard at the entrance to a Beijing residential area under Covid lockdown.

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Noel Celis/AFP/Getty Images

A difficult year is almost over. It is hard to know whether 2023 will bring easier times, and perhaps it isn’t even important.

We seem to have grown more resilient after a few years of constantly confronting difficult issues that are slow to resolve. The list of challenges that we face is surprisingly long and diverse.

We are reminded daily of historically high inflation. The specter of World War III remains in Eastern Europe. Troubled supply chains still impede our desire for instant gratification. Interest rates are poised to keep rising, though perhaps not for as long as anticipated. The Covid-19 pandemic still lingers. China’s counterbalance to U.S. economic and diplomatic strength looms larger as each day passes.

Rather than looking past those obstacles and trying to predict that this type of stock, in that type of sector, is poised to perform reasonably well in the new year, the better wager might be on a resolution to the very challenges that still oppress us.

The thinking is elemental. Investors overreact to almost everything. The market mob is either too optimistic or too morose. Positioning for the pendulum to swing from one extreme to the other is thus a reasonable posture—especially if it can be done in a cost-effective fashion.

We recently suggested a way to position in case the Federal Reserve normalizes monetary policy without causing a recession. Now, let’s consider China, which might be the only investment opportunity that causes more consternation than cryptocurrencies. It has earned a reputation as the place where Western money goes to die.

The world’s second-largest economy has been largely closed for several years. The country is trying to rid itself of the coronavirus with draconian measures that have crippled commerce and markets. In recent weeks, however, there has been increasing speculation that China could be preparing to reopen its economy sometime in 2023.

Goldman Sachs recently advised clients that China could be the only major economy that generates positive growth in 2023. The bank’s economists expect that China’s real gross domestic product will be 4.5% in 2023, up from 3% in 2022, as the nation transitions, as expected, from its zero-Covid policy in the second quarter of 2023.

The
iShares China Large-Cap
exchange-traded fund (ticker: FXI), which comprises many of the country’s top stocks, has gained more than 20% in recent weeks. The extraordinary performance offers a hint of what might come if the nation truly reopens.

China won’t remain shuttered forever. In anticipation that the country reopens by the middle of next year, aggressive investors could buy the iShares ETF’s June $27 call option, which cost about $1.90 when the ETF was around $25. The call purchase is a simple bet that the ETF will trade above $27 by the time the June call expires. If it is at $35, for instance, the call is worth $8.

The risk to the wager—and it is just that because it’s impossible to predict the actions of China’s rulers—is that the country simply doesn’t reopen. Should that happen, the ETF would probably decline. If it is below $27 at expiration, the money spent on the call would be lost.

During the past 52 weeks, the ETF has ranged from $20.87 to $40.18. It has lost about 36% of its value over the past year.

As fantastical as it might seem to look to China for investment gains, the nation is in a singular position. Central banks all over the world are raising interest rates to battle inflation, and yet China seems to be in a better position. The outcome is far from certain, of course, but the risk of the wager is defined.

Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in the story.

Credit: marketwatch.com

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