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Chinese Market Sizzling Hot (Again), But Be Careful at Trader’s Narrative





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While the US market has been incredibly strong, the Chinese stock market, by comparison, makes it look downright flaccid.

A few months back we looked at the Shanghai Stock Exchange Composite and noticed that the Chinese equivalent of the Coppock Curve had turned positive. As well, just a few weeks before this long term signal was given, we had another important positive development: a golden cross. Since then prices have climbed in what can only be described as a trend followers dream.

shanghai composite index rally 2009

That was a good place to go long Chinese equities (green up arrow). Since then the Shanghai Composite has climbed by 37%. But if you were reading this blog way back in early November 2008, I wrote about the extremely negative sentiment in China towards stocks and how this was a great contrarian indicator.

Back in November 2008, the Shanghai Composite was trading around 1700 - pretty much nailing the exact bottom (green up arrow). With the Shanghai Composite now trading at 3438, that’s 100%+ in 9 months.

So obviously, everyone all of a sudden loves Chinese stocks now. Their IPOs are popping like crazy. Just today China State Construction Engineering opened at 6.70 yuan, well above its initial public offering price of 4.18 yuan and closed on heavy volume at 7.30 yuan. It is telling about where the future global epicenter will be when the largest global IPO so far this year is Chinese.

A good old IPO frenzy is a sure sign of a sentiment extreme, just like billboards lampooning the stock market are a contrarian indicator at the bottom. But there are other signs of caution.

The last time the Shanghai Composite closed this far from its simple 50 moving day average was way back in October 2007… just as the market was making its top at slightly under 6100. And the last time the index closed this far above its 200 day simple moving average was in November 2007. Again, not a good time to be long this market.

Also, notice that simple support and resistance highlights this level as congestion going back to the spring of 2008. As prices were falling last year, they were met with strong support around this area. The Shanghai Composite thrashed about as prices disturbed their smooth downtrend. So this same area is now resistance as it acted as support before.

There is no question that things are really stretched at this point in Chinese equities. Of course, price can always continue but if you’re sitting on nice gains, it doesn’t make sense to continue to ride them as the odds are now totally skewed against you. The time to go long Chinese stocks was when no one wanted them, late last year as I pointed out back then.

From a long term perspective, having being blessed with both the “golden cross” and the Coppock Guide upturn, the best is yet to come. But not before we have a pull-back to shake out the weak hands. So unless you are ready to ride so major turbulence, it would be smart to lighten up here and ring the cash register.

If you’re not going to listen to me, consider Jeremy Grantham; who was correctly pessimistic and called the bear market as well as the spring rally this year. In his recent report, the chief investment strategist at Boston-based institutional money manager GMO writes:

Deciphering the strength of the Chinese economy will also play a major role in formulating our view of any future relative strength of emerging. My colleague, Edward Chancellor, strongly suspects that the Chinese economy is dangerously unbalanced and very likely to come unhinged in the next few quarters, surprising the pants off investors. On the other hand, the strong longer-term case that I outlined in “The Emerging Emerging Bubble” 15 months ago seems intact. I suggested then that emerging equities would sell within fi ve years or so at a distinct P/E premium to celebrate their obviously superior GDP growth compared with that of an aging developed world. Emerging market equities are already selling at a modest premium to EAFE and the higher quality half of the U.S. equity market.

Being pro-emerging yet anti-China is a dilemma for us; we are working to resolve it. Meanwhile, emerging equities, like most risky asset components, are moderately overpriced. We in asset allocation may, however, push our luck in emerging – particularly ex-China emerging – using inertia to reduce our current modest overweight. If we do this, it will be out of respect for the high probability that emerging equities will sustain and increase their overpriced level relative to the rest of the world.

You can download the complete report from Jeremy Grantham from the FREE Trading Resource Section (in the Reports folder). There is a lot of other stuff you might like as well, so take a look around.

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8 Responses to “Chinese Market Sizzling Hot (Again), But Be Careful”  

  1. 1 Conor Neu

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    Shanghai market crashed tonight. Down as much as 7.6% intraday and finished down 5%. Nice timing on this one.

  2. 2 Babak

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    Conor, neat. But to be fair, the call was not for today or tomorrow.

  3. 3 jill

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    A couple of physicists made a good call

  4. 4 Babak

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    Jill, thanks - will take a look at that. Looks like it is our old friend Sornette!

  5. 5 Malevich

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    Babak, thanks for your blog and informative postings.

    If you are still looking for it, this link provides some info on the modified Coppock Curve used by Investor’s Chronicle
    [Open in new window]

  6. 6 Babak

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    Malevich, you’re welcome :) yes, investors chronicle does mention it regularly but they use a simple or modified calculation not the traditional formula.

  7. 7 Nicholas

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    The SSE closed 3321 today. We are heading for the 4000 - 5000 region

  8. 8 Dave

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    Bull mkts are often marked by brief downdrafts. There’s a saying in poker “If you don’t know who the fish is, the fish must be YOU”.

    If you’re selling AFTER a bull mkt downdraft, you’re one of the weak hands.

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