This market is a ‘bear trap’ so here’s what to buy, strategist says

There will also be the matter of a Federal Reserve policy decision on Wednesday. No change in rates is expected, but traders will be highly sensitive to guidance on the chances of falling borrowing costs in coming months. The Treasury quarterly refunding announcement could also move bond yields.

And dovetailing with that will be the slew of jobs data over the week, culminating Friday with the January nonfarm payrolls report. Meanwhile, geopolitical tensions are increasing.

Good luck to investors tempted to second guess all that. Yet, it may take even braver traders to consider our call of the day from Evercore ISI: buy China.

As many will know, Chinese equities have been having a very hard time in recent years. A week ago Hong Kong’s Hang Seng hit a 14-month low and the Shanghai Composite touched a near four-year trough as investors worried about the cratering property market, relatively slow economic growth and tensions between Washington and Beijing.

But those indices have shown small indications of a revival since then, after Beijing talked of trying to support market sentiment and the People’s Bank of China said it would boost liquidity by cutting bank’s reserve requirements by 50 basis points in early February.

The strategy team at Evercore, led by Julian Emanuel, reckons the authorities stepped in when the Shanghai Composite breached what they term the “National Fate Line,” and they see a further policy response following the March 5 meeting of the National People’s Congress.

Such moves will be partly designed to lift the nation’s consumer confidence and this delivers Evercore’s first play, buying U.S. stocks with large exposure to China.

For example, companies who derive more than 10% of revenue from China, and for which Evercore has an outperform rating, include Estee Lauder EL, TE Connectivity TEL, and of course, Apple AAPL.

But it is equities listed in Hong Kong, or H shares, that has particularly piqued Evercore’s interest, and they suggest playing this through the iShares China Large-Cap exchange traded fund , which closely correlates to the Hang Seng.

That’s because mainland China stocks are currently trading at a greater-than-decade high premium to their offshore peers. Evercore notes that the last time the H shares traded at a similar discount in October 2022, the Hang Seng saw a greater than 55% trough to peak rally in less than two months.

Sentiment is thoroughly bearish. Early last week there were 88% of Hang Seng index stocks below their 200 day moving average. These extremes can trigger rapid rebounds

“A shift in sentiment could skew risk-reward positive,” says Evercore, particularly given short positions in the FXI is at all time highs. Such a “bear trap can catalyze rapid upside,” they add.

A bear trap, the opposite of the more commonly used value trap, is a false indication that a security will decline in value.

Beyond the technical factors there are also more fundamental reasons to look at the Hang Seng/FXI. The Hang Seng’s current 12-month forward price/earnings multiple of 8 is near its pandemic and great financial crisis lows. “That equates to a 30%+ discount to average PE over the past 10 years – the steepest discount relative to its own history globally,” the Evercore team write.

Compared to the S&P 500, the Hang Seng’s PE multiple is trading at a record 60% discount to the S&P 500. Even a reversion to a 40% discount would imply 50% relative gains for the Hang Seng, Evercore reckons.

For investors with access to such trades, and the intestinal fortitude, Evercore suggests buying the FXI March 28 calls at a strike price of $23.5. Implied volatility is reasonably priced given event risk, they say.

They also ran a screen on U.S. listed China ADRs, considering stocks with a greater-than $1 billion market cap; those that either trade at a 50% or greater discount to their 10-year average, or are still 50% below pandemic peak; and those expected to grow earnings in both this year and next.

The top 10 on the list by valuation are Alibaba BABA, Baidu BIDU, JD.com JD, Li Auto LI, Trip.com TCOM, ZTO Express ZTO, Vipshop VIPS, Full Truck Alliance YMM, Futu FUTU, and MINISO Group MNSO.

Markets

U.S. stock-index futures ES00 YM00 NQ00 are little changed as benchmark Treasury yields dip. The dollar is up, while oil prices CL slip after recent strength and gold GC00 trades near $2,030 an ounce.

For more market updates plus actionable trade ideas for stocks, options and crypto, subscribe to MarketDiem by Investor’s Business Daily.

The buzz

SoFi Technologies SOFI stock is up nearly 10% after the financial-technology company rode surging lending volumes to better-than-expected profitability for the latest quarter.

Whirlpool WHR, Cleveland-Cliffs CLF and Nucor NUE will report results after the closing bell.

iRobot shares IRBT are down 17% after the Roomba maker and Amazon.com AMZN said they are terminating their planned acquisition agreement because they believe there’s no path to regulatory approval in the European Union.

There are no notable U.S. economic reports due Monday.

Oil prices CL BRN00 traded near their highest in two months amid fears of supply disruption in the Middle East after Washington vowed to retaliate for a deadly attack on U.S. service personnel.

China property developer Evergrande is to be liquidated after debt talks fail.

Philips NL:PHIA PHG said it will halt the sales of new sleep-therapy devices in the U.S., as part of a broader settlement that led the company to take a €363 million ($393 million) provision.

Best of the web

A famed analyst’s final forecast is the fall of the U.S. economy.

Europe chafes at America’s protectionist tilt.

Wall Street titans are betting big on insurers. What could go wrong?

The chart

Calm down about the Fed. Everything is normal and on course. That’s the message, sort of, from this chart via Torsten Slok, chief economist at Apollo Global. “If the Fed cuts in March, it will be eight months after the last Fed hike, which is exactly the average of all previous Fed hike cycles,” he says.

Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

Random reads

That’ll wipe the smile off her face!

Italian speed camera vigilante.

Elderly woman leaves £2.2 million to her pets.

Need to Know starts early and is updated until the opening bell, but sign up here to get it delivered once to your email box. The emailed version will be sent out at about 7:30 a.m. Eastern.

Check out On Watch by MarketWatch, a weekly podcast about the financial news we’re all watching – and how that’s affecting the economy and your wallet. MarketWatch’s Jeremy Owens trains his eye on what’s driving markets and offers insights that will help you make more informed money decisions. Subscribe on Spotify and Apple.