Market Stimulus is Failing, Big Time
On August 25, 2015, we said the following:
“The actions of the Chinese government have not been constructive for a change in the declining trend of the market. The sooner restrictions intended to stop prices from falling are lifted the better the chance for Chinese stocks to fully recover.”
Since the very first clear intervention by the Chinese government on June 27, 2015, with a surprise interest rate cut, the Shanghai Composite Index has declined –40.77%. The total decline from the 5,166.35 peak on June 12, 2015 has been –48.09%.
That very first stimulus action of cutting interest rates and the laundry list of interventions (partial list here) since is now being compounded by company buyback of shares.
Since 2009, stock buybacks have generally increased over time. However, the year 2018 has seen a dramatic increase that has overshadowed all prior years of data as referenced from the September 12, 2018 Financial Sense article titled “Chinese Government Encourages Share Buybacks As Bear Market Deepens” by contributor Danielle Park.
The intervention is actually causing the process of recovery to take longer than it needs to by providing false hope for investors (large and small) that the turnaround is near. We’ve seen this all before in the Japanese Nikkei Index from 1990 to 2009 when it declined –81% (chart here).
Failure in Our Analysis
On September 26, 2016, we said the following of the Shanghai Composite Index:
“A simple flag or pennant formation seems easy to identify. Now it is time to see if the direction of the index will do a retest of the late January 2016 low.”
If viewed from the perspective of the pennant formation starting from late January 2016, our analysis was a failure, as seen in the chart below. Even if we were to extend and enlarge the pennant from the early January 2016 start date to December 15, 2017, the pennant would have been a failure.
Based on the original analysis, the index was supposed to drop –13% to achieve a retest of the 2,655.66 low. Instead, the index increased +16.50% to 3,559.47 before starting the descent to 2,655.66. The idea of a retest of the prior low is based on Dow Theory and has been proven to be very consistent. However, as analysts, it requires time and patience to see the process through.
Below are the downside targets and the potential upside targets for the Shanghai Composite Index.
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