Category Archives: Shanghai Composite Index

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Market Stimulus is Failing, Big Time

On August 25, 2015, we said the following:

“The actions of the Chinese government have not been constructive for a change in the declining trend of the market.  The sooner restrictions intended to stop prices from falling are lifted the better the chance for Chinese stocks to fully recover.”

Since the very first clear intervention by the Chinese government on June 27, 2015, with a surprise interest rate cut, the Shanghai Composite Index has declined –40.77%.  The total decline from the 5,166.35 peak on June 12, 2015 has been –48.09%.

That very first stimulus action of cutting interest rates and the laundry list of interventions (partial list here) since is now being compounded by company buyback of shares.

Since 2009, stock buybacks have generally increased over time.  However, the year 2018 has seen a dramatic increase that has overshadowed all prior years of data as referenced from the September 12, 2018 Financial Sense article titled “Chinese Government Encourages Share Buybacks As Bear Market Deepens” by contributor Danielle Park.

The intervention is actually causing the process of recovery to take longer than it needs to by providing false hope for investors (large and small) that the turnaround is near.  We’ve seen this all before in the Japanese Nikkei Index from 1990 to 2009 when it declined –81% (chart here).

Failure in Our Analysis

On September 26, 2016, we said the following of the Shanghai Composite Index:

“A simple flag or pennant formation seems easy to identify.  Now it is time to see if the direction of the index will do a retest of the late January 2016 low.”

If viewed from the perspective of the pennant formation starting from late January 2016, our analysis was a failure, as seen in the chart below.  Even if we were to extend and enlarge the pennant from the early January 2016 start date to December 15, 2017, the pennant would have been a failure.

Based on the original analysis, the index was supposed to drop –13% to achieve a retest of the 2,655.66 low.  Instead, the index increased +16.50% to 3,559.47 before starting the descent to 2,655.66. The idea of a retest of the prior low is based on Dow Theory and has been proven to be very consistent.  However, as analysts, it requires time and patience to see the process through.

Below are the downside targets and the potential upside targets for the Shanghai Composite Index.

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In past articles, we have pointed to the fact that government stimulus directed at the economy or the stock market has little effect (2016, 2014, 2011, 2009).  So it is with little wonder that we look at the situation of the Shanghai Composite Index for indications of the effectiveness of direct stock market intervention by the Chinese government.

On June 27, 2015, after the Shanghai Index had declined more than –20%, the government stepped in to shore up the stock market with a surprise interest rate cut.  That rate cut and many other actions that followed was cause for many analysts to carry on with the superstitious belief that government intervention could stop stock market declines and actually boost the market.  Many analysts were openly recommending Chinese stocks since the government had openly declared a goal to stop the stock market decline.

The following is a list of known interventions that was presented by Quartz Media writers Heather Timmons and Lily Kuo published on July 28, 2015 in an article titled “A complete list of the Chinese government’s stock-market stimulus”:

• June 27: A surprise 25 basis point interest rate cut and lowering of the reserves banks need to keep when they lend to companies.
• June 29: Regulators say pension funds can invest 30% of their net assets (equivalent to more than $100 billion) in equities for the first time.
• July 1: China’s securities regulator relaxes rules on margin financing, or trading stocks with borrowed money.
• July 3: China’s central bank extends a 250 billion RMB ($40 billion), six-month loan to state owned banks to “encourage banks to increase support” to weak parts of the economy.
• July 4: 21 brokerages, led by Citic Securities, say they will invest $19.3 billion in a new blue-chip fund to stabilize the market, and vow not to sell any of their own proprietary equity holdings.
• July 5: 28 firms planning IPOs on the Shanghai and Shenzhen market say they will postpone them and start refunding investors’ capital.
• July 5: China’s central bank says it will inject an undisclosed amount of capital into China Securities Finance Corp (CSF), a state-owned company that makes margin loans to brokers.
• July 6: Executives from mutual funds pledge to support the markets with their own capital.
• July 8: Regulators banned company shareholders with stakes of more than 5% from selling for the next six months. China’s central bank said it would further support the margin lending provider CSF through interbank lending, bond issuance, and collateral backed financing and re-lending. China’s securities regulator also said it would increase purchases of small-cap stocks.
• July 9: China’s banking regulator, the CBRC, said banks can now loan money to companies using stock as collateral, and ease margin requirements for wealth management customers.
• July 9: China Development Bank and the Export-Import Bank of China said they would not sell shares, and look to buy more stock.
• July 27: Margin lending provider CSF will continue to buy stocks to stabilize the market, and China’s stock market regulator, the CSRC, will investigate “huge stock sell-offs,” the CSRC said.

Since the initiation of these government actions to prop up the stock market, the Shanghai Composite Index declined an additional –34.40% to the low of January 28, 2016 and three years later lingers at a loss of –18.40% based on the starting point of the market stimulus of June 27, 2015.  In total, the Shanghai Index is down –35.98% from the peak on June 12, 2015.

We cannot emphasis enough how government stimulus has marginal long-term impact on the direction of the stock market and the economy.  Interestingly, buyers of Chinese ETFs at the current levels would be considered value investors as opposed to those buying in 2015 based on government promises to prop the market.

A simple flag or pennant formation seems easy to identify.  Now it is time to see if the direction of the index will do a retest of the late January 2016 low.

For anyone following the Shanghai Composite Index, we appear to be on the cusp of a significant change in the Index.  Below is what we believe to be a “flag” or “pennant” formation that is about to come to a conclusion. First, let’s address what a “flag” or “pennant” formation is from the most credible source on technical analysis.

“A Flag looks like a flag on the chart.  That is, it does if it appears in an up trend; the picture is naturally turned upside down in a down trend.  It might be described as a small, compact parallelogram of price fluctuations, or tilted rectangle, which slopes back moderately against the prevailing trend (Robert Edwards & John Magee. Technical Analysis of Stock Trends. International Technical Analysis Publishers, Boston. 1991 edition. page 202).”

Additionally, Edwards and Magee said the following of this consolidation pattern:

“These pretty little patterns of consolidation are justly regarded as among the most dependable of chart formations, both as to directional and measuring indications.  They do fail occasionally but almost never without giving warning before the pattern itself is completed (Robert Edwards & John Magee. Technical Analysis of Stock Trends. International Technical Analysis Publishers, Boston. 1991 edition. page 211)."

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