It's time to leave the hottest stock market in the world.
In a note Tuesday, US Trust's Joseph Quinlan wrote that since the firm upgraded China to "Overweight" on January 26, Shanghai's composite A-share Index has rallied more than 50%. The S&P 500 gained 2.6% in that same time.
"The rocket fuel for the rally: easy monetary policies and multiple measures of fiscal stimulus, in addition to market liberalization—measures that have encouraged capital inflows.
While these variables remain intact, and while China remains an investor favorite, we suggest investors take some profits at this juncture; we are shifting our market preference to neutral from overweight as China navigates some very stormy weather over the medium term."
Quinlan wrote that China is in the middle of a "perfect storm," with weaker-than-expected growth, a stock market that's surging anyway, and rising geopolitical tensions with the US that could hurt trade.
China's real gross domestic product rose 7% year-over-year in the first quarter, the slowest pace in six years, and Quinlan argues that the days of this level of growth are over.
Nearly half of all the 31 provinces contracted, and several metrics measuring the strength of the economy — including industrial production, exports and capital production, have slowed in the last year.
Some investors believe that China's stock market is being pumped by the government, and so it's irrelevant that there's a disconnect between the rally and economic reality.
But Quinlan wrote:
"Investors beware: Boons can become bubbles very quickly and take on a life of their own, irrespective of the powers of government, leaving in their wake a wave of destruction and investor remorse. Exhibit 1 makes it painfully clear."
For investors who stay put, Quinlan recommends that they buy selectively into stocks companies that have a solid future with rich earnings potential.
Here's Quinlan's chart of Chinese stocks over the past 10 years and the surge in 2015.
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