Trader’s Narrative

The last time I revisited the Chinese stock market, it was in the throes of a major bear market. Fast forwarding to now shows things have only intensified with the Shanghai composite trading at less than half of its top in October 2007:

While we quibble about a percentage point here and there to see if our market decline fits into the classic definition of a bear market, there are no qualms regarding that in China.

Support?
The scary thing is that even after falling so much, the index is still far from major support areas. If you look at the link above, you’ll see a long term chart of the Shanghai composite going back to its founding. According to that chart, significant support is somewhere in the vicinity of the 2000 level. That would put a potential fall to almost 70%!

I have no idea if that will happen but the Chinese stock market certainly has precedent. It is not for the faint of heart. The Shanghai Composite can go ballistic: rising as it going ten fold in the span of a year (1991-1992) but it can also lapse into deep stagnation, as it did from 2000 to 2007, treading sideways.

Dire Portents
But what interests me more is the portent of such a dramatic decline for the price of crude oil. From what I read, China holds significant responsibility for the current price of oil because of its voracious appetite. But if the stock market is a forward discounting mechanism, that means that the Chinese economy is about to decelerate or even go into a tailspin.

The corollary of that is lower demand for oil and, if I remember Economics 101 correctly, that would mean a lower oil price - all things being equal.

It pays to step back once in a while and take a really long term view of things. Here’s a graph of the Shanghai Composite since its beginning in the early 1990’s.

The chart is log scaled so that each price movement represents the same percentage distance on the graph. This is a must when looking at a long term chart which has trended higher (as this one has). The other lines are a 200 and 50 day moving average.

The bubble we are seeing develop now is nothing compared to the one in 1991. Back then the Shanghai Composite increased more than 10 times in less than 2 years. Meanwhile, so far, we are seeing the current Shanghai market only quadruple from its 2005 low.

Of course, things didn’t end well after the first bubble burst. But then again, there weren’t nearly as many participants nor as much money being thrown around back then as it is now.

It took more than 7 years for the Shanghai market to finally reach and traverse its 1990’s bubble top. But when it did the 1250-1000 range became support (which launched the 2005 bull run).

If, I mean, when, it crashes again, it will probably find support in the 2250-1750 range (the resistance in 2000-2001). I don’t think there will be a huge impact on the Chinese economy when it does. Sure, there will be some riots, unrest and general malcontent. But the Chinese government will send some tanks into the street and once again remind everyone who is in control. And in the meanwhile, the factories will keep humming and the exports keep flowing.

After all, when you can no longer flip shares on the market for a profit, a steady job is not that bad after all.

In case you missed it, here’s how you can play the Chinese market from the US. Another way to play a bursting in the Chinese stock market bubble is through the commodities sector: precious and non-precious metals, oil and gas, agriculture, etc. They will all go down in sympathy with the Chinese market - if and when it does crash.