ETF Investors Shouldn't Try to Catch the Falling Knife in China | ETF Trends

While value bargain hunters may look to the pullback in China as a buying opportunity, ETF investors should reconsider the urge.

“For a long time I thought the market sentiment was so strong that we could overcome a mounting list of economic uncertainty,” Economist Mohamed El-Erian told CNBC. “But the coronavirus is different. It is big. It’s going to paralyze China. It’s going to cascade throughout the global economy.”

Year-to-date, the iShares MSCI China ETF (NASDAQ: MCHI), the largest China ETF by assets, has declined 6.2% while the Xtrackers Harvest CSI 300 China A-Shares ETF (NYSEArca: ASHR), the largest China A-shares related ETF, dropped 10.9%.

In a Financial Times article, El-Erian argued that for the markets are in for a big economic shock that could derail global growth and shake markets out of their “buy-the-dip” conditioning. Specifically, he argued that the coronavirus outbreak amplifies structurally weak global growth and less effective central banks.

“Importantly, it cannot be countered by central bank policy,” El-Erian told CNBC. “We should pay more attention to this. And we should try and resist our inclination to buy the dip.”

El-Erian believed that it is becoming harder for markets to adapt to new risks, especially with old risk still hanging over the markets, including the recurrence of trade tensions, growing realization of the impact of climate change, technological shocks, political polarization and changing demographics.

On the ground, consumers can already see the negative effects of this new coronavirus risk. For example, Chinese store face disruptions with Beijing implementing a quarantine policy while suppliers are finding it harder to move products with many industries prolonging a holiday to stem the spread of the virus. There has also been a big drop in travel in and out of China.

“This virtual stoppage of economic activities is cascading throughout the second-largest economy in the world, and one with considerable regional and global ties. It is fundamentally weakening the country’s services sector, at a time of considerable challenges for manufacturing,” El-Erian said.

Alternatively, traders who believe the worst is not yet over may consider ETFs strategies to hedge against a further drawdown.

For example, the ProShares Short FTSEChina 50 (NYSEArca: YXI) takes the simple inverse or -100% daily performance of the FTSE China 50 Index. The ProShares UltraShort FTSE China 50 (NYSEArca: FXP) attempts to deliver double the daily inverse or -200% returns of the same index. More aggressive traders may look to something like the Direxion Daily FTSE China Bear 3X Shares (NYSEArca: YANG), which takes three times the inverse or -300% daily performance of the FTSE China 50 Index.

The Direxion Daily CSI 300 China A Share Bear 1x Shares (NYSEArca: CHAD) was the first inverse A-shares ETF to trade in the U.S. The ETF is designed to deliver the daily inverse performance of the CSI 300 Index.

For more information on the Chinese markets, visit our China category.