The Dragon Roars

With the KLCI making an impressive run-up in the last two weeks, we were thinking about making a call to take profits today. Coincidentally the Chinese Dragon choose yesterday and today to wake up from its slumber, which has increased our optimism and at the same time making it harder for us to determine the direction of the KLCI ahead. After some research suggested a high correlation between the KLCI and the Shanghai bourses, it is more difficult to be on the pessimistic side of the market.

China Bottoming up
With the Shanghai stock market having corrected by around 50% to the 3000 level, the Government has decided that it is time to bring the retailers back into the market. The Government announced a string of measures to encourage retailers back into the market. Among the measures are:

~ Tax on stock transactions reduced
The transaction tax on stocks has been reduced from 0.3% to 0.1% which essentially has done away with the previous hike which was implemented a year ago.

~ Restriction on large equity sales
China has also restricted the sale of large blocks of shares via the open market. Under new regulations, large blocks of shares exceeding 1% of a company’s total shares will have to be sold off the market in a venue where negotiations can be conducted. The authorities would also have to be notified of the sale one month in advance. This move would stave off substantial shareholders unloading huge blocks of stocks in the open market and help restore retailer confidence.

KLCI highly correlated with Shanghai Composite Index
Our research has shown that the correlation between the KLCI and the Shanghai Index is an impressive 93%. This would suggest that the KLCI is a very strong follower of the direction of the Shanghai Index. Now that the Shanghai Index has a strong upward bias, it is obvious that the KLCI will see a similar uplifting force too.

Note of caution: KLCI not guaranteed to go upwards
A note of caution though, an upward direction is not guaranteed for the KLCI as currently Europe’s liquidity problems and the US housing downturn does not justify the KLCI going up too fast in such a short time span. There are currently two conflicting forces at play which is the bullish China factor and the bearish economic downturn in Europe and US. The clash of these two equally strong forces will bring about very high volatility to our local KLCI in the short term.

Strategy: Take gradual profits and trade in China Call Warrants
With the KLCI already running up by over 5% in the last two weeks, it might be appropriate for traders to start taking profits gradually and slowly and wait for more meaningful entries. To gain some perspective, most of our recommended stocks over the last few weeks have rallied by as much as 20%-50%, which signals that local stocks are slightly toppish now. It’s never wrong to lock in profits in rallying stocks and look for more meaningful entries later. Traders still on the buying side can still find trading opportunities in China call warrants and safer counters which have not made movements yet such as Axis Real Investment Trust, Dutaland and Affin Holdings. Long term investors on the other hand may take this bullish opportunity to also take partial profits and marginally reduce their exposure while maintaining the core of their holdings to ride through the volatile next few months.

In short, traders are advised to take profits on high movement stocks and can still find safe opportunities in quality stocks which have not moved. Investors can take small gradual profits and choose to hold on to their core of holdings to ride out the volatile storms ahead.