Chinese stocks are rallying. The iShares MSCI China ETF (NASDAQ:MCHI) has rallied 27% from early August lows and reached an 18-month high last week. Widely-held names like Alibaba (NYSE:BABA) and JD.com (NASDAQ:JD) have performed even better.
Progress with the trade war is one factor, but it’s far from the only one. U.S. equities have rallied nicely over the same stretch. The rally in Chinese stocks began before good news arrived; to some investors, those stocks were just too cheap.
The concern now is that they might be too expensive. After all, risks abound. The country’s reported gross domestic product growth for the fourth quarter looks solid at 6.1%, but skepticism about reported numbers persists. Tariffs will remain in place for at least 2020, and many American companies already have shifted to suppliers elsewhere in Asia. And China, despite its massive potential, remains a country governed by a single, nominally Communist, party.
Tuesday’s big stock charts feature three Chinese names that have rallied of late, along with their peers. And like many of their peers, the key near-term question is whether another reversal is on the way. In at least one case, the chart strongly suggests it is.
Game developer NetEase (NASDAQ:NTES) has been one of the market’s best stocks over the past six-plus months. The first of Tuesday’s big stock charts suggests that can continue if the group cooperates:
- NTES stock has established a classic uptrend, with a rally over the past few weeks moving back to the high end of the channel. The 20-day moving average has provided support pretty much all the way up. There’s been a bit of consolidation in recent sessions, but no real technical reason to see a reversal.
- Fundamentally, the stock looks attractive as well. NTES trades at just over 20x the fiscal 2020 earnings per share estimate. Such a multiple for China’s leading developer seems well worth paying, given that U.S. gaming plays like Activision Blizzard (NASDAQ:ATVI) and Electronic Arts (NASDAQ:EA) are more expensive, and presumably have a shorter runway for growth.
- Of course, those comparisons do highlight a key risk here: will investors prefer the certainty of U.S. developers to the in-country risks faced by NetEase? Most Chinese stocks trade at a discount to their American counterparts. Meanwhile, NTES stock has run past the average Wall Street price target, and is just shy of 2017 highs.
- As a result, this looks like a stock whose direction may well be determined by broader sentiment. If Chinese stocks keep rallying, analysts likely will raise their targets, adding more catalysts to the rally. Any weakness in the group, however, and NTES seems like a prime candidate for profit-taking.
A huge rally in Chinese e-commerce play Pinduoduo (NASDAQ:PDD) was interrupted by a third quarter earnings miss in November. PDD stock managed to claw back those losses — but at the moment, the second of our big stock charts strongly suggests a downside reversal:
- The technical concerns are myriad. PDD stock has established a bearish head-and-shoulders pattern. A narrowing wedge pattern usually means a stock accelerates in the direction of its exit. If the H&S pattern plays out, and PDD exits the wedge to the downside, there’s a clear path to a recent key level just above $30. Even the “fill the gap” move following the post-earnings sell-off came on thin volume, which suggests minimal conviction.
- Fundamentally, there’s a case for downside as well. Pinduoduo isn’t profitable yet, though analysts see a 22 cent profit in 2020. Revenue growth is impressive: the top line rose 123% year-over-year in the third quarter. But Pinduoduo is paying for that growth: total costs increased 137% y/y in the quarter. Trading in JD stock, which in 2018 lost two-thirds of its value in less than a year, shows what happens when a Chinese growth stock disappoints on the margin front.
- So while NTES could use some help from bullish sentiment, PDD seems to require it. There are simply too many risks here, both fundamental and technical, for shares to rise in anything but a nearly perfect external environment.
China Mobile (CHL)
After touching a ten-year low, shares of China Mobile (NYSE:CHL) finally found a bottom in early December. But as the third of Tuesday’s big stock charts shows, resistance looms:
- A bounce off early August highs, along with other Chinese names, wound up fading. Several rallies toward or near current levels failed. But this time might be different. CHL has seen strong volume in early 2020, and a “cup and handle” pattern seems to suggest the stock can break through resistance and keep rallying.
- Fundamentally, CHL stock still looks cheap, as I detailed just before Christmas. Its 4.5% dividend yield and sub-11x forward P/E multiple both are favorable relative to Verizon Communications (NYSE:VZ). AT&T (NYSE:T) looks slightly more favorable on both bases, but faces pressure from its debt load and declines at its DIRECTV unit. A so-called “Barron’s bounce” after that publication highlighted the bull case for CHL on Dec. 20 has helped the recent rally — but even after that rally, the case holds.
- Broader sentiment matters. But there are other risks. Growth already is stalling out, with revenue declining 0.6% in local currency in the first half of 2019. The dividend was reduced as well (though the payout historically has been variable, unlike that of most U.S. companies who pay dividends).
- CHL stock is cheap, and there are plenty of reasons to believe the rally will continue, both in terms of the fundamentals and the chart. But there are reasons why the stock hit a 10-year low just last month, too.
As of this writing, Vince Martin has no positions in any securities mentioned.