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.
Upside Targets
The upside targets are:
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3,107.51
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3,261.17
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3,410.32
What does in mean if the upside lines are penetrated? In the case of the 3,107.51 line, it would be penetrated to the upside if the price exceeds 2,905.56. When and/if this occurs, our expectation is that the index will achieved the 3,107.51 level, at minimum.
Keep in mind that as time passes, these upside targets will eventually have less dramatic slopes making it easier to achieve the upside target without as much volatility. Currently, it would take an increase of +8.35% to achieve confirmation that the 3,107.51 level will be accomplished. Although the Shanghai index can be volatile, we would not trust that such a short term increase would have much in the way of longevity. Rapid changes favor declines and not increases in the market.
Downside Targets
The downside targets are:
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2,103.86
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1,722.12
To arrive at the remaining downside targets, we had to revert to the point of origin for the rally and subsequent crash in the index from 2014. When we ran the usual Speed Resistance Lines, we got 4,012.56, 2,867.34, and 1722.12.
Clearly we have accomplished both the 4,012.56 & 2,867.34 level. This left us with the 1,722.12 level and nothing else in between. When we break down the 2,867.34 to 1,722.12 level into thirds we arrive at 2,485.60 & 2,103.86 as the levels in between. However, when attempting to graph this, we find that the 2,485.60 level has already been accomplished. This leaves us with only 2,103.86 and 1,722.12 as the only downside targets that fit within the range of reasonable expectation based on the SRLs.
We’ve highlighted the 2,103.86 downside target. If this is achieved then we’ll highlight the last downside target of 1,722.12. We don’t expected the decline to fall to such a level but that would be all the more reason for the extreme downside target to be achieved.