YINN: The End Of COVID Lockdowns Could Have An Explosive Impact (NYSEARCA:YINN)

China is one of the world’s two most populous countries, with more than 1.4 billion people, running neck and neck with India. Meanwhile, the Chinese economy is second only to the United States and is nipping on the US’s heels for the leadership position. Competition between the US and China has increased over the past years, and in 2022, political tensions have increased. Under the previous US administration, trade barriers and tariffs intensified.

China and Russia agreed on a massive trade package in February 2022 and a “no-limits” alliance that challenges the US and Europe. Russia’s invasion of Ukraine, starting the first major European war since World War II, came less than one month after President Xi and President Putin shook hands during the opening ceremonies of the 2022 Beijing Winter Olympics. China has not condemned Russia for its quest for territorial expansion.

Just as Russia considers Ukraine a part of its territory, the Chinese leadership believes Taiwan is Chinese land. Tensions between the US and China have increased after the US Speaker of the House of Representatives’ recent visit to Taipei, affirming the US support for a sovereign Taiwan. Chinese companies have attracted capital in the US markets for years as the US equity markets offer significant liquidity. Meanwhile, the events over the past few years and the deterioration of Chinese-US relations have caused many investors to get cold feet for investing in leading Chinese companies. While the US stock market rose to all-time highs in late 2021 and early 2022, the iShares Chinese Large-Cap ETF product (FXI) has not approached its late 2007 peak. The shares in the leading Chinese companies offer value compared to US stocks, but investors remain fearful, causing a substantial underperformance.

The Direxion Daily FTSE China Bull 3X Shares product (NYSEARCA:YINN) is a short-term trading tool for market participants who believe the FXI and Chinese shares will recover as investors and market participants take advantage of some compelling valuations.

Chinese stocks have lagged behind US stocks

The S&P 500 index provides the most diversified exposure to the US stock market.

The chart highlights that while the S&P 500 index was 13.2% lower as of Aug. 22, it was 88.8% higher than the March 2022 low.

Meanwhile, the iShares China Large Cap ETF product (FXI) fell 19.6% in 2022 and was 21.7% lower than the March 2020 low on Aug. 22, 2022. Chinese stocks have underperformed US shares in 2022 and since the March 2020 pandemic-inspired low.

Over the past few years, investors have avoided Chinese stocks because of trade issues under the Trump administration and rising tensions under the Biden administration. In 2022, the “no-limits” alliance with Russia, Russia’s invasion of Ukraine, and China’s desire for reunification with Taiwan have made Chinese stocks toxic for many US investors. Markets reflect the economic and geopolitical landscapes, which have caused China’s leading stocks to lag far behind the US stock market.

Charlie Munger remains committed to BABA

Warren Buffet and his partner, Charlie Munger, are value investors. While many investors worry about the potential delistings for Chinese stocks, Mr. Munger continues to hold shares in Alibaba (BABA), the Chinese e-commerce giant.

At the end of the second quarter of 2022, Charlie Munger held 300,000 BABA shares, representing 19.50% of his portfolio. BABA is Munger’s third-largest holding. As a value investor, the Oracle of Omaha’s partner believes BABA is an inexpensive stock, and the potential rewards of holding the leading Chinese company are worth the risks that have scared many other investors away.

The chart shows BABA is the leading holding of the diversified Chinese large-cap ETF (FXI). At $90.03 per share on Aug. 22, Mr. Munger’s holdings have declined in value but still reflect an over $27 million exposure. While $27 million is nothing to sneeze at, it reflects only a little over 1.2% of his $2.2 billion net worth. He likely views BABA as a call option on a recovery in Chinese stocks without an expiration date.

COVID-19 has weighed on equities

China’s zero tolerance for COVID-19 and lockdowns over the past few months have weighed on its economy. In Q2, the Chinese GDP grew by a lower-than-expected 0.4%. Over the past few weeks, China has slashed short-term interest rates to spur growth as economic growth has lagged far behind the 5.5% target. While rates are rising in the US, the People’s Bank of China is on a dovish monetary policy path.

China had to reinstate COVID-19 lockdowns as new cases spiked in 2022, weighing on economic growth, global commodities, and share prices.

The three factors that could propel Chinese stocks over the coming months

While geopolitical tensions remain at the highest level in history, weighing on Chinese shares, at least three factors could bail Mr. Munger out and cause a sudden and sharp recovery in the leading Chinese stocks trading on the US stock market:

• An end to Chinese lockdowns that cause economic growth will likely lift stocks.
• A diplomatic solution to the war in Ukraine and tensions surrounding Taiwan will cause a tsunami of buying in undervalued Chinese stocks.
• The upcoming Chinese Communist Congress that will likely award President Xi another term and lifetime leadership could cause a shift to a more accommodative stance that seeks peace and trade with the US and Europe to spur economic growth. The markets expect an aggressive path. Any surprises could cause buying in Chinese shares.

Charlie Munger believes the upside potential in Chinese stocks compensates for the high risk level. If he’s correct, BABA and the other leading Chinese large-cap stocks have lots of upside potential at current valuations.

YINN is a turbocharged product: Trade with price and time stops

The fund summary for the leveraged Direxion Daily FTSE China Bull 3X Shares product (YINN) states:

The bearish product is the YANG ETF. At $62.26 on August 22, YINN had over $380 million in assets under management and trades an average of over 719,500 shares daily. The ETF charges a 1.42% management fee.

The most recent rally in the FXI ETF took it from $27.83 on May 12 to a high of $34.83 on June 28, a 25.2% increase.

Over the same period, YINN rose from $57.41 to $106.86 per share, or 86.1%, slightly more than triple the increase in the unleveraged FXI ETF.

YINN is for bulls, and YANG for bears, and neither is for the faint of heart. These turbocharged products come with an additional risk – time decay. Therefore, they are only appropriate for short-term risk positions. Market participants who agree with Charlie Munger should use time and price stops when using the YINN ETF as it decays over time. Meanwhile, if Chinese stocks suddenly take off on the upside, it will surprise the market, and the YINN ETF could provide substantial short-term rewards.