During the first peaks of the Covid crisis when there were widespread lockdowns, there was a concern that the full economic impact was not being reflected in market activity. Like economist Stephen Roach, I felt this contradiction would be resolved by the market pulling back to match the economic fundamentals of business hibernation. Both of us were wrong, although this did not prevent me from accumulating some good profits during this period.
We find ourselves again in a contradictory situation when it comes to China and its relationship with the world economy. It is no secret that US policy under Trump, and now Biden, was designed to reduce the economic exchanges with China. This meant a drop in imports from China and measures to reduce foreign investment in China.
Alarmed at China’s technological advances, the US instituted a range of restrictions on sales of high-tech products to China and Chinese investment in the US, and continues to heavily tax imports from China.
The pandemic caused temporary global shortages of medical equipment, which was overwhelmingly produced in China. This raised concerns about the dependence on imports for key products and led to calls for increased domestic production of these items — and, more broadly, calls to develop economic sovereignty.
These were the political headlines for 2020 and it is reasonable to expect they would lead to a significant impact on China’s economic relationships. Indeed, we have written about this and the need for caution many times.
But, like the relationship between the Covid economy and the market, there is a contradiction between anticipated results and what is happening on the ground. There will be some permanent changes in the foreign investment and trade landscape, but it is unlikely to be as great as politicians expect.
Many aspects of trade and investment showed limited adverse impacts in 2020. US import prices fell by only 1%, even though world GDP dropped by 3.4%. Put this down to US economic stimulus measures.
US trade data recorded just a small decline of 3.6% in imports from China, despite new tariffs of 25%. This suggests Americans still want Chinese electronic products, medical equipment, protective gear and other products. The disruptions were expected to fall most heavily on companies like Walmart which relied on cheaper Chinese imports to sustain their business model. In truth, the disruptions were minimal.
The Trump administration urged US firms to leave China and ‘‘reshore’’ to America. Biden continued this narrative in his 100-day address to the Congress, telling them that there are no reasons why goods could not be produced in America.
However, there is little evidence that “reshoring” is happening. Surveys of American firms in China have repeatedly found the vast majority are expanding their footprint in China. Very few are returning production to the US because they do not want to miss out on China’s lucrative domestic market.
In addition, not only are American firms not moving back to the US, but about onesixth are considering moving some production to other lower-wage countries. This is also reflected in recent moves by General Motors to shift new electric vehicle production to Mexico.
The reality is that after initial disruptions caused by the mismanagement of Covid outbreaks, the global value chains have proved particularly resilient and efficient. The multinational value chain includes many different types of intellectual properties from brands to managerial know-how and sales networks. David Dollar at the Brookings Institution estimates that “85 % of the value of the large firms in the S&P 500 index consists of IPs. Operating globally enables these firms to use their assets in the largest market possible” and China is a market too large to ignore.
China and the Western business engagement with it are not going to go away. Despite the contradiction posed by the political commentary and its associated punitive legislation, the actual “on the ground” activity has not diminished. That said, Western business engagement with China carries an increasing level of political risk which cannot be entirely ignored.
When we apply technical analysis to a chart of price activity, we believe the chart when there is a contradiction between it and investment analysis based on company fundamentals and accounts. Investors need to employ a similar test when evaluating the rhetoric around China engagement and the actual figures tracking China engagement.
Technical outlook for the Shanghai market
The Shanghai market is closed for the Labour Day holiday, so this brief update covers just a few days of trading.
The Shanghai Index retreat found support near the value of the uptrend line. This now gives the uptrend line four anchor points.
This forms an up-sloping triangle pattern. The base of the pattern is 125 index points. Taking this value and projecting it above 3,460 gives a target near 3,585. This is a theoretical target because it does not match any previous support resistance levels. In this bullish situation, it is not unusual for the market rise to exceed the chart pattern target and reach the next resistance level near 3,620.
The Guppy Multiple Moving Average (GMMA) indicator is used to assess the way the breakout trend may develop in the future following the current index rebound from the uptrend line.
The continued compression in the longterm group of averages group confirms investors are not strongly bearish. This suggests the potential for a breakout trend.
The short-term group of GMMA averages provides information about traders. The short-term GMMA still remained inside the long-term GMMA when the market dipped during the week. This shows traders are growing more confident.
