Diary of a Financier

China: Fractal Frames a Final Descent, but a Bottom’s Been Spotted

In Capital Markets on Fri 15 Jun 2012 at 10:26

I wanted to discuss the Chinese status, since I judge this to be another turning point. For the first time in years, I find their broad market valuations inexpensive. However, the problem with relying on any valuation is that investor psychology swings market values around that guidepost like a tetherball.

That goes doubly for the Chinese, for a few reasons. First, their data integrity has proven anything but reliable, so shocks to fundamental inputs occur here and there. Second, markets overshoot the downside with the same gusto that they had blow past the upside, almost inertially. With the substantial leverage in the Chinese system and the lack of automatic social stabilizers, she’s not an exception.

Technicals communicate that psychology. The Shanghai (SHGIDX) is -34% from its 2009 high, -28% from the 2010 breakout highs. Those peak-to-trough numbers mean nothing to me, but a zoomed-out view of the chart puts it all into context, exhibiting a steady, corkscrew decline after the violent 2008 correction:

SHGIDX long term decay

Over that entire period, China was among the fastest growing countries in the world–a feat achieved with remarkable poise. Yet, its equity market died a slow, quiet death for 5 of the 7 years depicted above. Think about that. Think about all the Emerging Markets bulls on CNBC, with their “EMs have a place in everyone’s portfolio” and their “valutation doesn’t matter for a country with 1.3 billion consumers.” The whole time, China was in decline.

I lambasted China throughout these years gone-by. I was a lonely bear with that one. I’m still bearish, in fact:

I look to my SHGIDX 2011 analogue and find technical footing. There, I find our year-to-date Shanghai having formed a reproduction of last year’s priceaction. This self-similar repetition is fractal by definition:

SHGIDX 2011 analogue- daily shows fractal construction that should roll over now.

Despite my near-term apprehension, the fundamental argument I originally introduced herein frames a more constructive long-term:

  • #China will event’ly stabilize $CNY when consumptn supplants fixed inv + exports; they’ll draw-dwn commod stockpiles. That’s when I buy $FXI.
    Jun 13 @ 11:54pm

Australia is still going to struggle in adjusting to this whole new world, the post-Commodity Super-Cycle. Meanwhile, China has the consumers and a rising middle class. They have the surplus to tap, the stockpiles to draw-upon, and the currency to strengthen in promotion of a more endogenous economy. Further, all these things swim with the natural current of the global economy.

The shift is underway, especially since private investment is displacing some of the government’s void in fixed investment. That will prove insufficient to prolong y/y growth in the macro “Investment” component, particularly considering the amount of overinvestment in the last 3 years. More importantly, the government is reallocating expenditures into soft investments like education, healthcare, social security/employment, and the environment. Most importantly, Consumption accounted for more than half of Chinese GDP in 2011, a rise that broke ten years worth of decline. Consumption growth also accounted for ~75% of GDP growth in 1q12. CLSA recently published a brilliant slide deck about this whole transformation:

20120615-101958.jpg

Technically, the Shanghai is stuck in a big bear channel. Since YE2011, it started fighting to maintain a long-term support trendline. I don’t expect this to hold, because of its weak construction and the bearish weekly & monthly fractals. That being said, the daily chart exhibits a classic bull falling wedge:

SHGIDX daily- bull falling wedge within bear channel is my focus; weak LT trendline support (~2300) shouldn’t hold.

The Chinese index will slide into the vertex of that falling wedge, and after one last bump of the blue support trendline (<2075), it should stage a steady reversal… then a breakout rally to end the larger bear channel.

–Romeo

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