(Mar 13): Cash liquidity not Covid-19 is now the immediate issue for China. With the rate of domestic infections reportedly at zero, the attention now returns to the shape of a stimulus package to bring a battered economy back up to speed.
At the same time, Western markets are going into meltdown and lockdown in reaction to Covid-19 in their own environments. The impact is likely to be far greater than the impact in China. In the United States, access to healthcare is expensive. It is beyond the means of the poor and much of the lower middle class. The most common cause of bankruptcies is medical bills.
Put bluntly, people in these groups cannot afford Covid-19 testing or treatment and so this becomes a reservoir of infection and contagion. The economic impacts will be substantial and payroll tax relief is a drop in the ocean. This is relevant because it suggests that, as China recovers, the international demand for Chinese exports will not be at pre-Covid-19 levels.
The dynamics of widespread panic brought on by Covid-19 and fuelled by social media gossip, are poorly understood. This widespread panic is the key difference between the GFC and the Covid-19 crisis and this means the solutions are different.
The panic is not economic or monetary, although it effects both these aspects of the economy. The panic is emotional and irrational, as are many of the leadership reactions.
The GFC called for replacement and stimulation of market demand as Western markets contracted due to a credit-crunch and economic restructuring. Banks were either unable, or reluctant to lend so the “oil” that lubricated the market disappeared and government stepped in to fill the gap. China’s infrastructure stimulus was an appropriate answer. It remains debatable whether the Western monetary policy response of ever lower interest rates was appropriate.
Covid-19 is not a structural reshaping of economic fundamentals. It is a hiatus — a temporary suspension of normal activity. Covid-19 delivers an economic impact but in itself, it is not the cause of the impact in the same way that the GFC grew from credit mismanagement. This hiatus delivers a cash and cash flow crisis. It calls for a recapitalisation of Chinese business so they can meet established demand for food, services, goods and export markets.
It is not that people cannot be paid because demand has collapsed — that was the GFC. They cannot be paid because business activity has been temporarily suspended by Covid-19 quarantine. That calls for a stimulus of an entirely different nature to put cash back into business so they can pay wages.
There is no shortage of capital or credit flexibility in China, although the same cannot be said for the United States and some of the Eurozone countries. The China recovery stimulus rests on the redeployment and redirection of capital investment, not on the creation of credit and jobs via infrastructure projects.
Mr Ma’s noodle shop does not benefit from a new freeway. Ms Chen’s service sector business does not need a new bridge over the Yangtze. They need capital relief from fees and charges so they can restore business to meet existing demand after the Covid-19 hiatus. Just how this will develop will define the coming investment opportunities. However, we can reasonably anticipate a decline in new foreign investment from China and potentially a withdrawal from existing foreign investments.
Technical outlook for the Shanghai market
The resilience in the Shanghai Index is remarkable. Following the gap down and retreat on February 28, the index then rebounded strongly. The rebound returned the index to the relatively narrow trading band between 2,980 and 3,040. This behaviour adds new analysis tools to the understanding of the Shanghai Index.
The retreat and rebound behaviour enable the placement of an uptrend line. The behaviour of the Shanghai index since making the low of 2,783 is no longer characterised as a rally. It can now be defined as an uptrend because there are two anchor points for the uptrend line.
A reliable trend line has three anchor points, each a created by a clear retreat and rebound point. The low of these patterns is used as the anchor point for the trend line. The low point of the retreat and rebound at 2,879 provides the second anchor point for the uptrend line.
Investors now wait for a second retreat and rebound to establish the third anchor point for the trend line. If successful, this will involve a test of the new uptrend line value currently near 2,930. A rebound from this support feature enabled the Shanghai index to again move into the narrow sideways trading band between 2,980 and 3,040.
Some observers have suggested the longer-term pattern in the Shanghai Index shows a head-and-shoulder trend reversal pattern. The left shoulder is the high near 3,039 in December 2019. The head is the peak near 3,127 in January. The right shoulder is the peak near 3059 in February.
This is not a valid head-and-shoulder pattern. The pattern is an end of trend pattern that develops after a prolonged uptrend. The features on the index chart come after a prolonged sideways pattern and the high near 3,127 is well below the 2019 peak high of 3,288 in 2019 April. Additionally, the head-and-shoulder pattern does not usually include market disruptions which lead to massive market retreats as occurred in February. This unusual behaviour invalidates many of the usual pattern developments.
The focus for Shanghai Index development is the strength of historical support near 2,980 and the test of the new support feature provided by the value of the new uptrend line. The bottom of a new retreat and rally sequence may lead to the adjustment of the position of the new uptrend line, but this will not be confirmed for another week or more.
A fall below the new trend line has support near 2,850.
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 more than a decade. 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.
