How Low Can China Go? More Downside Possible If This Happens (And Here's A Way To Play It)

As UBS analysts anticipated, the RMB was included in the IMF’s SDR basket, with an adjusted weight above those of the JPY and the GBP, but below those of the USD and the euro. This is the first developing country currency to be included in the SDR basket, and it implies a big advance for the RMB’s internationalization, the report explicated.

Over the short term, the analysts expect the impact of this inclusion on liquidity to be skewed to neutral, as demand would be limited and the transition gradual. In addition, they noted, “The US Fed may raise interest rates in December,” likely putting the RMB under “continued depreciation and capital outflow pressure.”

Related Link: It Might Be Time For China ETFs Again

Longer term, the firm thinks the RMB’s inclusion in the SMB should improve the currency’s international status as overseas demand increases. “However, foreign investors’ exposure to RMB-denominated assets will also depend on domestic economic situation, liquidity conditions and financial systems, meaning adding exposure is likely to be a gradual process,” the note continued.

As the end of the year gets closer, they went on, investors should keep a close eye on the impact that liquidity disruption has on the stock market. “Apart from seasonal funding stress, the resumption of IPO is expected to freeze up cRmb1 trillion of funds as the first batch of companies (10) has started to issue shares for Rmb3.94 billion,” they expounded.

“The remaining 18 companies will complete their issuance by the year-end, which is expected to lock up nearly Rmb2 trillion of funds. The PE (ttm) of the Chi-Next board has returned to 85x, equivalent to the level seen in April. Any liquidity disruption could lead to a market correction as investors' sentiment tends to be more fragile under high market valuations,” they concluded.

Risks Involved

To finish, the experts looked into the medium-term downside risks to the A-share market. These include: “1) credit events that give rise to shocks to the financial system, leading to tighter liquidity conditions; 2) a lack of meaningful progress on reforms; 3) large capital outflows driven by currency depreciation expectations or changes in global financial conditions; and 4) weaker-than-expected earnings growth.”

How To Play This

One binary way to play continued weakness in China is via binary options on the China 50.

Investing via binary options is just that: Playing a binary event. “Binary options are limited risk contracts based on a simple yes/no market proposition like will the markets go up by the end of the trading week,” binary options trading site Nadex explained.

So, on the one hand, there are investors thinking the weakness in China will continue, and wish to profit from this. For them, playing the bearish side of the binary option could be a good idea.

On the other side, some may be expecting recovery, possibly supported by government-backed supply-side policies. If this were to happen, the bullish side of the binary could be played.

To know which stocks are actually in play, check out a full list of the China A50 Index components here.

Related Link: Taiwan Enters Recession As China's Industrial Sector Is In Freefall

Some popular stocks included in this index are:

• Bank of China Limited (HKG:3988)
• China Railway Group Ltd (HKG:0390)
• PetroChina Company Limited (SHA:601857) (ADR) PTR
• Industrial and Coml Bank of China Ltd (HKG:1398)

Disclosure: Javier Hasse holds no positions in any of the securities mentioned above.