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Is China a leading indicator? Part 4
I have been tracking the Shanghai Composite Index on this blog since August 2009, when it made a sharp 20% correction. When I last looked at the Shanghai Composite Index on December 22, 2009, it looked like it was on the verge of breaking the long-term up trend line that started from November 2008. It has since broken that trend line but instead of falling sharply like it did in August 2009, it has gone sideways this time. Looking at the weekly chart below, there does not appear to be any panic selling, but rather lack of interest in buying.
I started tracking this index when I noticed that it was the first index to rally in November 2008. Australia’s All Ordinaries only started to rally about four months later in March 2009, so I thought that it may be a good leading indicator to watch as to what may possibly happen in the Australian markets a few months later. China is also Australia’s biggest customer so what happens in China will have an impact on Australia. So far the correlation appears intact. The Australian market looks like it may have peaked in January 2010, about five months after China’s market peaked in August 2009. After a sharp 10% correction, the market has rallied to try to retest the January highs as shown in the chart below of the Australian All Ordinaries. If China is a leading indicator, we should expect this test to fail i.e. the AORD will fail to make a new high and we should drift sideways for the next few months.
If we take a look at the daily chart for the Shanghai Composite Index (see chart below), it looks mildly bearish. We can draw a slightly bearish downtrend line (i.e. blue line) from the series of lower highs from November 2009 to January 2010. A more bearish secondary trend line (i.e. purple line) can be drawn by connecting the series of lower highs from January to March 2010. Prices seem to have difficulty moving above the 50 day moving average as well. Last Friday, after the CPI numbers were announced, prices fell below the 200 day moving average, which is a sell signal for some institutional investors. Of course short-term charts are not as reliable so we should still maintain a neutral outlook until prices break below 2650, which was the low reached in September 2009.
From a fundamental perspective, there is not much to spur prices to go up higher. The effects of stimulus spending is wearing off. The Chinese government has been tightening on lending by lowering the lending quota for 2010 and demanding banks to maintain higher reserves. With the higher than expected inflation numbers announced last Friday, it is anticipated that interest rates will rise as well and all this will contribute to slowing down the economy in 2010.
I don’t expect any surprises to the upside. Good news like improving export numbers have already been priced in the rally, and has not been able to move the markets up further. If there are any sudden moves, I think it would more likely be to the down side. Professor Victor Shih from Northwestern University in Chicago has spent months researching borrowing transactions by about 8,000 local-government entities in China. On March 5, 2010, the Ministry of Finance announced that it will ban all future guarantees by local governments and legislatures may be issued as soon as this month. China’s local governments have been raising funds through investment vehicles to circumvent regulations that prevent them from borrowing directly. Professor Shih believes that a crackdown on local government borrowing, estimated at about 24 trillion yuan ($3.5 trillion), could trigger a “gigantic wave” of bad loans as projects are left without funding. If this happens, we may see some big moves to the down side.
In summary, barring any surprise new announcements by the Chinese government, we should have a few slow months ahead of us. I will be back with another quarterly report in June 2010.
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[...] above, we can see that the index has clearly broken below the trading range noted in my last post Is China a leading indicator? Part 4 on Mar [...]