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A Made in China Recovery

The Shanghai Composite Index (SCI) has gained a remarkable 40 percent since the low of October, 2008. Other than this outstanding growth, the most important feature of the market is the way it points to the potential bottom pattern development in Western markets.

Feeling the full brunt of the global financial crisis, many people outside naturally like to believe there's something unsustainable about the China recovery. After all, if our home market is so bad, how can the Chinese market be so good?

The chart analysis confirms the strength and stability of this market consolidation and accumulation trend breakout behavior. We need to consider other factors to help explain why the chart pattern has developed. And its all about confidence and domestic economic growth.

There are three significant small changes in China which are greater than the sum of their parts. They provide the foundation for optimism inside China. They are:

  1. Changes to the hukou system
  2. Changes to land transfer procedures
  3. Directives to banks on small scale lending

The hukou system is a relic of the old Chinese economy based on work units and local registrations (work permits) that made casual migration almost impossible. Without a hukou it was difficult to get legal employment in another city or location.

The abolition of hukou requirements mean that people can now work wherever they wish without the need to co-ordinate with their local work unit (danwei). The flow of fresh university graduates and of displaced workers, is now free to find work wherever available, without the old work permit obstacles.

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Land transfer regulations have also been changed. Now individual landholders can transfer land in their own names, which makes buying and selling much easier.

Government policy encourages banks to loosen up small scale lending to fund the establishment of small scale business enterprises particularly in the rural areas. The shift back to countryside or rural areas is made easier by access to loans that will enable people to put their urban learned skills to good use.

Freeing graduates to find work, or to develop business in locations of their own choosing is a significant change in policy and approach. Enabling workers returning to the countryside to use their skills in small scale business made possible by more relaxed small enterprise funding, turns unemployment into a domestic economic growth opportunity.

The pattern of chart behavior in the SCI is a reflection of this optimism. The long term trend reversal and trend breakout has been defined by the pattern of six fan trend lines. The pattern starts with the 2009 January 15 high. The pattern has six fan trend lines. Each trend line acts as a resistance level, and then later as a support level. This is a pattern that signals a long-term change in the trend that often takes five to eight months to fully develop.

The fan trend line 6 starts on 2008, January 15 and touches the high point of February 17 and the third high point on March 9. In recent weeks fan trend line 6 has been a strong resistance level. The retreats from this resistance level have tested and retested support between 2000 and 2100. Fan trend line 6 will cross the support level at 2000 in the first week of April.

A breakout above fan trend line 6 can be very powerful. A breakout would move very quickly towards the next strong resistance band between 2600 and 3000.

If the index is unable to move above fan trend line 6, it will then drop below support at 2000. This would retest the lower support band between 1750 and 1800. In this situation the market would return to a sideways trading consolidation band. This delays the up trend reversal, but it does not signal a continuation of the long term downtrend. The consolidation period between 1750 and 2100 started in 2008 October and it has proved a strong area over the past 6 months.

The consolidation and potential for an uptrend breakout is also verified with the behavior of trading volume. It has increased and this shows more people are confident and active in the market. The volume increases when there is a rally in the index. When the index falls the volume also falls. This shows that people are not selling when the index retreats.

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Guppy Multiple Moving Averages (GMMA) relationships show developing long-term support for the trend. The long-term GMMA is moving sideways and it has shown very little evidence of compression during the recent market retreat. This confirms investors are buyers in this market and they used the index retreat as a buying opportunity. Many traders are ready to join the market when the index moves above the value of fan trend line 6.


If you would like Daryl to chart a specific stock, commodity or currency, please write to us at ChartingAsia@cnbc.com. We welcome all questions, comments and requests.

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  • Daryl Guppy is an independent technical analyst who appears frequently on CNBC Asia.

Asia Economy