Interactive Investor

Chart of the week: it may be time to think the unthinkable

6th June 2022 13:15

John Burford from interactive investor

Technical analyst John Burford has spotted a trade which he believes has limited downside and where the path of least resistance is up.

The tech sector is showing signs of life – should we buy?

Is it time to start thinking the unthinkable? By that I mean China – and in particular Chinese tech. As outrageous as this may sound, remember this is the Year of the Unthinkable.

Since the start of the year, both bonds and equities have been in record-setting bear markets together. And, for conventionally minded investors, that was unthinkable.

Why? Because textbook portfolio investing theory firmly states that a 'balanced' portfolio consists of a (moveable) 60/40 split of equities/bonds.

What is usually gained on the swings is lost on the roundabouts with the aim of smoothing the ups and downs in the portfolio valuation. Usually, bonds and equities move contra.

But what the textbook writers failed to take into account this year was a sudden jump in price inflation, combined with super-high share valuations together with a US central bank that is determined to sell off its mountain of bonds. Both bonds and shares were then poised to decline in tandem - and that is what they did, in spades.

And caught up in the rapidly rising interest rate backdrop was the highly vulnerable US tech sector, much of which is still losing money. In a rising interest rate scenario, that is a massive headwind.

A rally in China tech?

In China, at around the same time, the authorities decided to clamp down on the excesses of their tech names, with Alibaba founder Jack Ma one of the most targeted of the prominent tech tycoons. He has since departed, but the e-commerce company’s shares have lost an astonishing 77% of their value to the recent low.

Obviously, at some point the heavy selling of tech becomes overdone and it is then that the shares represent good value. I believe we have reached – or at least approached - that point now. My last two COTWs made a case for buying Amazon.com Inc (NASDAQ:AMZN) and Netflix Inc (NASDAQ:NFLX).

One of the more conservative ways to play a possible rally in China tech is through the Hong Kong Tech Index, which consists of 30 of the largest listed Chinese tech companies on the Hong Kong Stock Exchange.  These are mammoth companies.

This index was launched in July 2020 but already is highly liquid – an essential feature for me.

Past performance is not a guide to future performance.

It made its all-time high in February at 110 and has lost 70% to its March low but since then has been in consolidation. But just last week, it moved up to the extended trendline, joining the waves 2 and 4 highs and at a moment of truth.

Any firm move above this line would likely herald a much stronger advance with a major target around the 70 region. Remember, there are a great many shorts in the tech space and even a minor short squeeze would likely produce outsized gains.

There is little doubt that globally, tech sentiment remains highly depressed as the mainstream media spurts out bearish articles regularly. Here are two such recent Bloomberg headlines: 'No longer sure bets; Tech giants are dropping bad news daily' and 'The tech rout isn't just cyclical: it's well-earned and overdue'.

You get the picture. It is well-established that when the mainstream media take a highly dramatic bearish view of a market that has already fallen very hard, that is usually when a major reversal is near. In fact, it is one of my standard major contrarian indicators!

And with Amazon and Netflix – my recent COTWs - showing signs of life, we are likely to see similar stirrings in China Tech. I believe the downside is limited and the path of least resistance is up.

One way to play the theme is via Alibaba Group Holding Ltd ADR (NYSE:BABA), which is still making a great deal of profit. With the imminent easing of lockdowns in major Chinese cities, sentiment should start growing and support rallies.

John Burford is a freelance contributor and not a direct employee of interactive investor.

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