Is Chinese real estate actually suggesting a melt up…not down? (FXI, TAO, XHB, XLF)

Conditions in the Chinese property markets are endlessly controversial. But at the moment, the way the property stocks are behaving actually points to a move higher for Shanghai. As followers of my writings are aware, I focus my attention on intermarket analysis, which is designed to identify certain messages and disconnects which market participants are knowingly or unknowingly sending through price.

It was this very approach which led me to the conclusion that we were headed for a summer crash when I began writing about it in June of last year, well before the August/September declines.

The same methodology led me to conclude we could head for a “Fall Melt-Up” in stocks when I began writing about it in late September. I was even interviewed on October 5 making the case live a couple of days after the October low, just as the best month for equities in decades was ramping up.

Homebuilders in the U.S. (XHB) anticipated this as the group substantially began to outperform U.S. stocks following the October low.

Given the drag housing has been on the U.S. economy since 2005, suddenly out of nowhere investors began to bet on a recovery.

This optimism in turn has now filtered through to banks, which as we all know have been suffering as a result of falling collateral and home values.

It stands to reason then that if investors were strongly optimistic for a recovery in housing, that feeling would eventually transmit over to the financials sector (XLF), and finally to the broader stock market itself.

I believe China may be on the verge of a similar moment, a housing-driven “melt up” of its own. I say this because I have noticed an interesting similarity between China now and U.S. markets in October.

Take a look at the price ratio charts below: To the left is the price ratio of the SPDR S&P Homebuilders Index (XHB, quote) relative to the S&P 500 (IVV, quote). To the right is the price ratio of the Guggenheim China Real Estate ETF (TAO, quote) relative to the admittedly bank-heavy iShares FTSE China 25 Index Fund (FXI, quote).

As a reminder, a rising price ratio means the numerator — XHB or TAO, or “real estate,” in this case — is outperforming the denominator, the broad market here.

Notice the relative weakness in China’s real estate stocks, which start lagging in the middle of August while homebuilders in the U.S. started weakening in late June.

The pattern looks very similar to the relationship of China’s real estate stocks relative to China’s market itself. Could this be foretelling a big move to come in China?

After all, if bets are increasing on China’s real estate — which, like housing in the U.S., has been a drag on the economy — then wouldn’t it make sense that a strong recovery in China’s stock market would first express itself here first?

by Michael A. Gayed CFA for Emerging Money

The author, Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing. The commentary does not constitute individualized advice. The opinions herein are not personalized recommendations to buy, sell or hold securities.