Trader’s Narrative

The Coppock Curve or Guide is an obscure indicator which tracks the market over a long term time horizon. The indicator is quite simple to calculate but it moves very slowly. What it takes back through lag, it gives multiple fold through an uncanny prescience in determining significant turning points. For more information, check out my original post introducing the Coppock Guide.

Although originally created to track the US stock market, it can in effect be applied to any index. In fact last month, the Coppock Curve turned positive for the Chinese market. I’m relying on the slightly modified IC/Coppock Curve. Since they don’t exactly detail how their calculation is different than the traditional, I’ve contacted them to inquire. When I hear back I’ll update this.

As you can see from the Shanghai stock exchange index, that was quite a while after it actually bottomed. This the inherent disadvantage of such a long term indicator. But if you were a long time reader you would have caught what I wrote in early November 2008: Time to Consider Chinese Stocks. That’s almost to the day when the Chinese market bottomed. Lots of contrarian sentiment, a little dash of technical analysis and a pinch of luck

Since the day I suggested the long side of the Chinese market, the Shanghai index has appreciated by 53%. The numerous ETFs and securities I mentioned have also gone up - the ones that haven’t, bottomed in late rather than early November 2008:

• Morgan Stanley’s China A-Share Fund (CAF) — 80%
• Taiwan Greater China Fund (TFC) — 5%
• The Greater China Fund Inc. (GCH) — 15%
• China Fund Inc. (CHN) — 21.5%
• JF China Region Fund Inc. (JFC) — 10%
• SPDR S&P China ETF (GXC) — 27%
• iShares FTSE/Xinhua China 25 Index (FXI) — 29%

The plus side to this is that if this is a true Coppock signal (that is not a false one) then we are in for another bull market in Shanghai which could last well into next year and take us back up to at least the mid-point of the two extremes - that is to the 3,800-4,000 level.

Also notice how the March 2009 swing low on the Shanghai index is higher than the October/November 2008 lows. And again, in early January 2009, when the S&P 500 was topping, Chinese equities were carving out another swing low. What we have here is higher lows, higher highs. In other words, a confirmed uptrend. And finally, the medium term (50 day - red line) moving average has turned up in support of price with the long term (150 day - blue line) moving average flattening. If this is what it looks like to be, then a pull back would present another opportunity to get on board a long term ride higher.

If you missed the China call and you’re kicking youself, do yourself a favor and grab my feed if you haven’t already and don’t overlook this next opportunity:

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While the Chinese stock market bubble was brewing, a lot of people ignored it and frothed at the mouth about the over-valuation in the US market.

In keeping with that odd behaviour, while the US market has now fallen less than half the distance of the Chinese market (from their respective October 2007 tops), most people are more concerned about the US markets and again are ignoring the very real and brutal bear market in China.

Part of the explanation is that the US markets are obviously much larger and have more significance on the world stage but still, a bear market is a bear market. And over in China they are grappling with a big one.

Bubble, Bubble, Toil & Trouble
The Chinese stock market has gone through bubbles before. This time it only multiplied by a factor of 6 in less than 2 years!

But tha’s nothing compared to 1991 when it multiplied by ten in about a year. Remarkably this recent mania was so strong that it shrugged off a trading stamp tax increase last summer and continued to rally for a few months. Usually such state manipulation would have meant a quick death to the mania.

Click To Enlarge Graph:
To the left is a graph showing the S&P 500 and the Shanghai Index since March 2003, the bottom of the last bear market.

Since the bull market in Chinese shares lasted longer than most predicted, it is safe to say that the bear may last longer also. The next level of support is around the 3000 level. After that, the resistance levels from 2000-2001 will come into play at the 2000 price levels.

Probably the best timer of Chinese stocks has been the editor of the newsletter, Cabot China & Emerging Markets Report. Their virtuoso performance in BRIC emerging markets brought them the trophy of the best newsletter in 2007. For the record, they turned negative in November 2007 right after the top and are continuing to stay away.

The editor, Paul Goodwin, uses an extremely simple way to enter and exit the market: 50 day and 25 day moving averages of Halter USX China Index (HXC). That’s it. Trading doesn’t have to be complicated.

Chinese ADRs
Although there are quiet a few individual Chinese ADRs trading on US exchanges, the only way that I know to actually trade Chinese equities (the A shares) is through the Morgan Stanley A Shares Fund (CAF). It has fallen from almost $61 in October 2007 to its current price in the low $30’s.

As a trading vehicle it is an imperfect one because it doesn’t track the Shanghai index very well. But unless I’m mistaken, it is the only way to get your hands on those A shares from outside China.

A “stamp duty” or “stamp tax” is an archaic form of tax which is basically a prerequisite for a document to become legally binding. For example, where levied, you would have to pay a stamp duty when you buy a house to have the deed reflect the new buyer’s claim on the property. Or when you buy stocks, to reflect the new owner.

Only a few developed places levy such taxes anymore: UK, Ireland, Australia and Hong Kong (now part of China). Usually the level of the tax is left untouched. In England for example, it has been at 0.5% since 1986.

But in China not only is it levied, stamp duties are one of the dials that the communist beaurocrats love to tweak up and down. The latest “tweak” was the announcement last week that it would be tripled to 0.3% effective this Wednesday (June 6th 2007).

I showed this graph before to demonstrate that there had been an even crazier bull market in China in the early 1990’s. In this new version it shows the dates of the previous stamp duty or stamp tax changes:

I think it is fairly probable that this increase in transaction costs will greatly reduce the mania in the Chinese equities market. It may not cause a full blown crash - although the market is down overnight as I type and is at a five week low. If you want to play the Chinese market here’s how to play it from the US.

The real question now is, where will all that money flow next? You can’t dam capital. It will find its way out, one way or the other. All you can do is try your darndest to channel it.

If they ask me (and they haven’t) I would say open the gates so that the Chinese can invest outside China.

Finally! The S&P 500 finished the day at 1530.23 - an all time high. Everybody was watching this level as it had been the line in the sand, drawn more than 7 years ago:

On March 24rd, 2000 the S&P 500 reached an intraday high of 1553 (red circle above). And for the next few months kept trying to go higher but each time it was pushed back.

In hindsight we know this level to be the last bull market top and the blow off of the internet bubble of 2000.

The interesting thing to note is that not only did the S&P 500 put in a very strong performance today, it did so in the face of some seemingly bearish cross-currents from China. Overnight, the Chinese authorities tripled their stamp tax on stock transactions in another attempt to cool the mania surging in their stock market. The Shanghai market dropped almost 7%. The last time China sneezed like that, we caught a cold (February/March 2007).

But now? We seem to have developed an immunity.

I find it still supportive that so many people, even active traders and investors, are in denial of what is right in front of their quote screens. I’ve already covered how the retail “Mom’n'Pop” investors are simply not interested. But I’m seeing much of the same from many experienced, knowledgeable market participants. They simply do not want to believe this is a bull market.

Which is more the reason why it is. And more reason why it has some ways to go.

Finally, we may very well see the market correct from this level and go into a range bound contraction as it digests the resistance. That would only be natural. In the medium to long term though, I think we are headed higher.

As I wrote yesterday, on that time horizon, it is foolish to bet against the house.

You know, I’m tired of people calling the US market a “bubble” or using words like “melt-up” or “buying panic” to describe it. These sort of pessimistic adjectives belies the bearish sentiment still pervasive in the wider market. If you want to see a real bubble in the making right now, you needn’t look far: China.

The Shanghai Composite has been on a rampage. Since bottoming in the summer of 2005 it has risen ~300%. Just recently, it hit a bump earlier this year and since bottoming in early February 2007 it has risen 50% (and counting). No matter how you look at it, China has gone parabolic.

The US large caps, which are currently leading the market, have put in a tame performance by comparison. They’ve only returned about a tenth of what the Chinese markets have. Still want to call it a bubble?

Keep in mind that I’m comparing the Shanghai Composite to the Dow and not the Shenzhen. That would make the comparison even more ridiculous since it has risen ~70% since its February 2007 bottom. By the way, this short term “speed bump” in the Chinese markets gave the world markets quite a jitter, if you recall.

Click to enlarge graph:

I’m not concerned about the US markets. But I am rather very concerned about what the Chinese bubble could mean for them. Technically speaking, the Shanghai market could fall 1000 points or about 25% and still be in a long term uptrend. How do you think the world markets would react to such a drop? what if it comes in a very short time?

The other reason I’m concerned is that the Chinese market, unlike the US markets or any of the other well established global financial markets, are riding on fumes. There is no substance behind the companies. Most of them are shells. The banks are in terrible shape. And most of the demand is internal with Chinese funnelling millions of Yuan towards a thinly veiled form of gambling.

When the Chinese bubble ends in tears (and it will… they all do) the Chinese market’s correction back to reality will effect the US markets more than anything stateside. This is something most people, both permabulls and permabears, are not yet cognizant of.