The Shanghai Composite and its Moment of Truth

Recent commentaries on the Chinese economy have been mixed. Some have chosen to focus on real estate problems and a potential banking crisis, whereas others place greater weight on recent reforms and a positive shift to a more consumer oriented economy as a justification for higher Chinese equity prices.

This dichotomy of opinion is reflected in the technical action of the Shanghai Composite, which is resting close to the apex of two key converging trendlines. That means that the moment of truth is probably close at hand. The market itself will make the final decision, but supplementary technical evidence favors a positive outcome. On the one hand, if the Index falls below the support trendline (1980) and the June 2013 intra-month low of 1850 such a significant technical break will be followed by an important extension to the secular bear market. This kind of weakness would also foreshadow trouble in the Chinese economy, with repercussions for other Asian markets, non-agricultural global commodity prices and possibly the US equity market itself.

Chart 1 Shanghai Composite 2000-2014
Source: Reuters

On the other hand, a break above 2180, would take the Index decisively back above the 2008-2014 down trendline at 2160 and suggest a test of the 2010 highs just below 3,000.  Positive factors include an upside penetration of the (dashed) 2007-2012 down trendline and a positive violation of the 2010-2014 downtrend in the 18-month rate-of-change in the lower window of the chart. A similar momentum break took place in 2006 and that was followed by a very spirited advance.

Chart 2 shows that long- and short-term momentums are also bullish. All of this suggests that the outcome will be a positive one for Chinese equities, industrial commodities and some Asian markets.

 Chart 2 Shanghai Composite and Two Momentum Indicators
 3.3.2104 pic 2
 Source: Reuters

It’s worth monitoring because the outcome, in whichever direction it breaks, will be felt well beyond the great Wall.

Martin Pring is the Investment Strategist to the AdvisorShares Pring Turner Business Cycle ETF (DBIZ)—and since 1984, he has published the “Intermarket Review,” a monthly global market report revered among analysts and market technicians. In his latest technical analysis, Martin weighs-in on indicators from the Shanghai Composite and what it may mean for the Chinese economy.