Time to Go Bearish On China? (FXP)

China’s growth story has been hard to ignore the last few years. The world’s largest country by population may still be considered an “emerging” market, but at least parts of China are as developed as anywhere else. China is now the third-largest economy in the world; GDP grew by almost 12% in the first quarter of this year. Some analysts think China may surpass Japan in the global GDP rankings.

We’ve discussed the benefits of playing China in the past, but the current environment more than highlights the risks of Chinese stocks. The Shanghai Composite Index closed at a seven-month low on Tuesday. Chinese large-cap stocks have been lackluster at best this year. That means the time may be right to look at the ProShares UltraShort FTSE/Xinhua China 25 ETF (FXP).

FXP is the bearish cousin of the well-known iShares FTSE/Xinhua China Index (FXI), the most liquid China-specific ETF. Investors should note that FXP is a double leveraged short fund. This means that it is designed to replicate two times the inverse of the DAILY performance of the index it tracks, and the leverage is reset daily. The effect is that over time, your returns can significantly diverge from the index. This adds to its risk, and it’s not the type of ETF that should be bought and held for extended periods.

With that caveat, let’s take a look at why FXP might be attractive right now. Because of China’s robust economic growth, Beijing has taken steps to keep inflation at bay. The main concern is the red-hot real estate market. Chinese property values have soared so much that investors fear a vicious bubble is forming. As a result, the government has raised down payment requirements for first-time home buyers as well as real estate investors.

Chinese equities and U.S.-listed ADRs and ETFs reacted poorly to that news. As if stricter loan requirements weren’t bad enough, the People’s Bank of China is actually forcing banks to loan less money this year. Regulators also raised capital reserve requirements for Chinese banks just last weekend.

It should be noted that the People’s Bank of China has not gone as far as raising interest rates, and it is clear that the PBOC prefers a more docile approach to reining in monetary policy. That said, Chinese stocks face plenty of near-term headwinds. Meanwhile the global risk appetite is evaporating thanks to Europe’s sovereign debt contagion. Whatever China’s long-term outlook, right now it is hard to advocate a bullish China position for the immediate future. That means the time is right to take a look at FXP.

If you buy FXP, make sure to set your profit targets and stops at appropriate levels. This one can run quickly in either direction. Proper trade management is essential for leveraged ETFs like FXP.

Disclosure covering writer, editor, publisher, and affiliates: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.