The Shanghai market collapsed dramatically last week in response to a government announcement in relation to the education coaching industry. The excessive market response was driven in part by the increasing influence of large-scale Western funds invested in China. Many of them lack real China expertise, so the tendency to overreact is understandable. The sell-off, like all market sell-offs, was further amplified by the activity of ETFs, which actively rebalance in response to market movements. This tends to create market over-reactions.
The sell-off has two factors for investors to consider. The first is the opportunity for bargain-hunting. The second relates to sovereign risk.
Bargain-hunters gather when markets get smashed because in this situation, good stocks get taken down along with every other stock. These general market sell-offs are a buying opportunity for some stocks. This week’s rebound in the Shanghai Index has as much to do with bargain-hunting, as it does with the soothing comments from the ViceChairman of the China Securities Regulatory Commission when he hosted a virtual call with global investment banks.
The sell-off developed when the government announced that the education coaching industry could no longer operate on a for-profit basis. It was a decision foreshadowed in May in a report on excessive afterschool coaching.
The selling also hit companies listed outside of China, such as TAL Education, China’s largest tutoring company, which is listed in New York.
The second factor for investors is the idea of sovereign risk. For many Western analysts, the education crackdown was a classic example of China government’s interference in the operation of the market. This is identified as a uniquely Chinese problem and a warning to all that China is a dangerous place to invest.
More rational analysis suggests these conclusions are inaccurate. Governments interfere with market operations all the time. We readily accept US government interference in markets, but are quick to call out Chinese government interference.
Take the current intense focus on the 10-year US bond rate. The decision around the underlying rate for US treasuries is taken by the government. It is one of the reasons investors assiduously watch these regular meetings. It is why statements from the US Federal Reserve and the Reserve Bank of Australia are analysed word by word. These government decisions impact markets, redirecting capital flows, boosting some stocks and decimating others.
Or consider the recent US government announcement that brought a sudden halt to all Chinese IPOs on US stock exchanges.
Add to this list of government interference the directives to force the sale of TikTok, hobble the operations of Huawei, and to direct US companies about what they can and cannot buy or export to China. These are all examples of direct government interference in markets. They have immediate and dramatic impact on individual stocks and market sectors.
The Chinese announcement in relation to education providers is not something unique to China. Governments interfere in the markets all the time, and investors need to factor this into every investment decision.
Technical outlook for the Shanghai market
The Shanghai Index’s collapse was followed by an equally rapid rebound. Trading opportunities delivering around 30% to 60% gains were the order for the past few days. The longer-term outlook remains more difficult to establish, but it looks like a return to the trading band behaviour that has dominated the index since the start of 2021.
The dominant feature of the index chart is the long-term support and resistance level near 3,450. The market has swung or oscillated around this level on a consistent basis. The upper point of the swing is the resistance level near 3,580. The lower limits of the swing are near 3,330. This level was briefly broken on an intraday basis, but the market quickly recovered.
The index spent the first five months of the year largely confined to the lower half of this oscillation band. There was a general upward trend defined by trendline A, and this led to the market breaking into the upper half of the oscillation band in late May.
The index enjoyed a few bullish months until the collapse below trendline A and the central support level near 3,450. The current rebound above 3,450 has the potential to lift the market into the upper half of this trading band. This is a bullish environment.
However, bullish sentiment is restrained by two features. The most immediate constraint is the value of trendline A. There is a high probability this will act as a resistance feature and block upward moves. Current value is near 3,530.
A successful break above trendline A still faces strong resistance from the upper edge of the trading and near 3,580. These two resistance features suggest that the index will be confined to the lower half of the upper section of the trading band for several weeks or longer. The rebound is healthy but has the characteristics of a rally, and not the characteristics of a sustainable uptrend. The key feature investors will watch for is the inability of the support level near 3,450 to hold and for the index to develop consolidation behaviour around this level. Further rally, retreat and rebound activity above 3,450 will enable the placement of a reliable trendline which can be used to define subsequent trend behaviour.
Until then, the index’s movement is treated as a fast-moving rally with the potential to collapse again below the 3,450 level and retest support near 3,330. This basic support and resistance analysis provides the most effective evaluation of the Shanghai index behaviour.
Daryl Guppy is an international financial technical analysis expert and special consultant to Axicorp. He has provided weekly Shanghai Index analysis for mainland Chinese media for two decades. Guppy appears regularly on CNBC Asia and is known as “The Chart Man”. He is a national board member of the Australia China Business Council. The writer owns China stock and index ETFs.
Photo: Bloomberg
