SINGAPORE (Jun 3): During the 19th century, China was a punching bag for Western powers. It is remembered by many Chinese as the “Century of Humiliation”, and there is a determination not to allow a repeat of this situation. This means China is not going to roll over to the increasingly belligerent demands of US President Donald Trump.0
The American narrative on the trade war is that some damage will be done to the US. This can be countered by subsidies such as the US$16 billion ($22 billion) in extra aid paid to US farmers. The narrative is confident that more damage will be done to the Chinese economy and that China will yield to all US demands.
This may be wishful thinking, as China has at least four significant responses it can pursue. Each has major significance for investors, capital markets and economic activity in our region.
The first of these four potential responses has already been foreshadowed by comments in the People’s Daily. China produces around 80% of the world’s supply of rare earths. These are essential in chip, battery and other high-tech products. Silicon Valley, the much-fabled source of American prosperity, relies on the free availability of these resource materials.
A ban on Chinese exports of rare earths, while not devastating, will have a severe impact on these products. Already, the price of rare earth from producers outside of China has seen a rise of 20% or more in anticipation of a ban. US tech companies will be the first to feel the pinch and perhaps offer an opportunity for short trading.
The second potential response is for China to allow an increasingly wider trading band for the renminbi in a move towards a partial free float. Many believe the true value of the renminbi is around 8 to the US dollar, although a line in the sand has been drawn at 7 to the US dollar. For Trump’s trade war to have its desired effect, the US really needs China to manipulate its currency so it stays below 7 to the US dollar. Any move above 7 to the US dollar means the impact of the trade war on Chinese exporters is progressively diluted.
It is an irony that the very feature that the US and Trump have been demanding of China for years — no manipulation of the renminbi exchange rate — is now the very thing they do not want to happen.
A renminbi above 7 to the US dollar changes the trade landscape and impacts directly on investments in our regional economies.
The third potential response is to stop buying US treasuries. China buying has already substantially reduced. China’s US Treasuries holdings are at their lowest levels since 2017.
A withdrawal of China as a major buyer raises questions about just how the US can finance its current debt, and the debt required to implement Trump’s programmes such as the infamous wall and the much-needed infrastructure build. Your bets on US construction companies may need to be reconsidered.
The fourth potential response is to start selling US Treasuries. China sold the most Treasuries in more than two years in March. China has now sold Treasuries every month since September. An increase in sales will put upward pressure on US interest rates. These are all potential responses, but they must be considered. The idea that China will accept US demands without making a response lives only in Trump’s mind. Investors must be more clear-headed.
Technical outlook for the Shanghai market
The Shanghai Index is pounding out a triple bottom near 2,830. This has become a major support area that has been successfully tested three times in the past 16 days. The success of these tests suggests the index is creating a base floor for a consolidation and a rebound. The long-term Guppy Multiple Moving Average (GMMA) indicator is compressed, and this suggests there is weak resistance for any rally to overcome.
This is not a bullish situation, but neither is it a bearish situation. In addition, the strength of support and the activity of the index around 2,830 have confirmed the development of a Relative Strength Index divergence pattern.
The current RSI divergence pattern has three equal lows separated by 11 days. The lows are connected by a horizontal trend line (B). The lows in the RSI indicator for the same period are connected by an upsloping line (B1). This is one of the weaker of RSI divergence patterns, but it is still a bullish indicator. The Shanghai Index is very compatible with the RSI divergence pattern. This means that when the pattern appears, there is a high probability that the current index trend will change.
The period leading up to the market retreat in April saw the development of the strongest type of RSI divergence. The trend line along the peaks of the Shanghai Index (A) moved in the opposite direction to the trend line (A1) placed along the peaks of the RSI indicator. Also, the peaks in the Shanghai Index activity were separated by several weeks.
The Shanghai Index is consolidating between 2,830 and 2,960.
This consolidation pattern suggests the strong selloff has ended. Traders have become more confident that the retreat has been arrested and they are entering the market as buyers. This is confirmed with the short-term GMMA developing compression and turning up. This is also confirmed with the behaviour of the long-term GMMA. This has turned down and compressed but the long-term GMMA has not started to expand.
An expanding long-term GMMA would show that investors have joined the selling. This is usually a signal for a strong downtrend. The current compression in the long-term GMMA shows that investors are undecided. They are cautious, but not yet bearish. It is comparatively easier for investors to turn bullish and support any rally from 2,830. If support near 2,830 is broken, then the next strong historical support level is near 2,700.
The area between 2,700 and 2,830 acted as a broad trading band during 2018. Traders and investors are alert for the potential for this trading band to again act as a support and consolidation area.
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.
