Tuesday, May 18, 2010

Is China Ending The Global Rally ?

The Shanghai Index is doing a frightening crash if you haven't noticed - down some 21% from its high last year. It has dived way below its 140 day ema, a good divider of bull and bear markets.
China has taken measures to cool down it's economy and make it a sustainable growth, but isn't this a good problem to have? Why is their market acting as if a huge, unavoidable recession is beginning when they've just tapped the brakes on a really good economy?

The China dive is probably one and the same with the euro dive. China lives and dies by its exports, and guess who is China's biggest trading partner. It's Europe. If you compare the charts of the euro and the Shanghai, you see that the decline in the euro began in December and soon began overwhelming China's stocks: (click to enlarge)

China stocks seem more worried about the European consumer than their own consumers. The market is vexed about this and not actual planned economic activity. You can see this by taking a look at China's version of the Dow Theory with the Baltic Dry index for shipping being their transports:

Th Baltic, like the Shanghai, is a leading index doing things at least a couple months ahead of the S&P 500. It put in a bottom in December ahead of the March '09 bottom. It did a big pullback in March ahead of the big July pullback. And it did another big pullback ending in October ahead of the one that ended in late January. So now the Shanghai is falling off a cliff. Egad, is this what's next for us? But the Baltic, in Dow Theory fashion, is not confirming this move by the Shanghai. Both have been tracing out a big cup and handle bottom pattern, but the Baltic doesn't speculate and is immune to the stock market's speculation. The BDI seems to be going through the typical cup and handle major cycle bottom with a break of the handle to the upside next. And it should be kept in mind that this index is now understating the bull case because of the over-build of ships coming online from the roaring commodities business of about 3 years ago (3 year build/lag time) otherwise, the handle may not have been as drawn out as it is.

In addition to China's tendency to follow the euro, this market could just be completing the common correction maneuver whereby the fundamentalists are ejected from the bull's back with something like the euro and the technicians are kicked off by a brief breakage of a widely followed TA condition. A large consolidation triangle in the Shanghai has been broken to the downside busting below the recent lows from the last correction. Markets are really dastardly that way. You can see an article on this over at safehaven. A similar thing happened back in the July correction bottom when everyone was horrified by the breakdown of the apparent head and shoulders top in the S&P.

Of all the key leader groups for the broad market, the Shanghai is the only one doing a technical breakdown, and this could be mainly a currency gyration, not the best thing to base stock cycles on. And the move it is making is not being confirmed by the Baltic. If you look at the technology leader group, you have a moving average condition typical of an ongoing bull market:

You don't see the breakdown below the 140 ema but a correction to this critical curve that looks to be bouncing around a bottom as it did in July and February, only with better A/D strength and a stronger economic recovery going. The 200/140 ma divergence shows no sign of breakdown in the RUT, RLX and other groups that have been leading since the middle of last year.

Sentiment is really sour right now as at all market bottoms. If you sample the comments at Seeking Alpha, they are as rabidly bearish as at about any bottom. And the CNBC opinions are at the extreme other end of the spectrum from the unbridled optimism before the correction. Just days before the correction began, Jim Cramer was crowing about the clear expressway to Dow 12000 and making fun of the "nattering nabobs of negativity". Now he's bitching about the "building skepticism". And an article I saw at safehaven shows that the big fund managers are at a max point of distribution and you dare not go against them. But wait a minute. Aren't these the same fund managers of whom over 70% don't outperform the S&P 500? Why would you want to do what they're doing? They were at about this same stage of distribution at the Feb 4 bottom.

Until more leader groups do a technical breakdown (and they may) you probably have to give the devious bull the benefit of the doubt.

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