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'Death cross' danger looms for China stocks

A highly bearish technical indicator is fast approaching for China stocks, in what could be the latest development that scares investors from the market.

Benchmark indices in Shanghai and Hong Kong are in sight of the "death cross" pattern, in which the simple 50-day moving average falls below the 200-day average. As of Thursday, the difference between the two indicators stood at 398 points for the Shanghai Composite and 108 points for the Hang Seng Index, narrower than in recent days.

For traders, the "death cross" indicates that a recent short-term decline is likely to evolve into a long-term downtrend.

"If the government is tiring of its intervention measures and the [Shanghai] market is continuing sideways around a 4000 level, the death cross could be particularly significant," Angus Nicholson, IG market analyst, commented in a recent note.

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A-shares had enjoyed a brief spell of stability following a stinging rout that kicked off in mid-June. Investors attributed the recent calm to the government's package of market-boosting policies, which include a ban on short-selling and widespread trading halts.

But losses returned this week after comments by China's securities regulator sparked fears that authorities would withdraw support measures, sending the Shanghai Composite tumbling 6 percent on Tuesday and 5 percent on Wednesday.

Volatility is a normal scenario for markets such as China when coming off such elevated peaks, independent analyst Fraser Howie told CNBC on Wednesday. The index hit a more than seven-year high on June 12 before succumbing to the severe sell-off.

"I'm not saying we're on the brink of collapse, but expect a general downward trend," he said.

Still, it would be highly unlikely Beijing would let local indices plummet given the aggressive nature of its ongoing intervention, noted IG's Nicholson.

Shanghai dragging down HK

Hong Kong's losses aren't as deep as the mainland, but they are gradually catching up. Since the A-share bloodbath began in June, Shanghai equities are 25 percent lower, compared to 15 percent for Hong Kong.

"H-shares are still influenced by the global economy, whereas China is more domestic-driven. U.S. shares are holding up well, so that's been giving Hong Kong life support all this while," explained Howie Lee, investment analyst at Phillip Futures.

The Dow Jones Industrial Average hit its own 'death cross' on August 11.

Lee believes H-shares were becoming increasingly correlated with A-shares as sentiment toward the latter market continued to deteriorate. He's bearish on both for now, comparing trading them to "catching a falling knife."

On the bright side, China's landmark yuan devaluation has improved prospects for Hong Kong stocks going forward. A weaker renminbi heightens Beijing's risk of capital flight, which could benefit Hong Kong, Nomura explained in a Thursday report.

Once the yuan stabilizes against the dollar, "outflows from China may find non-property Hong Kong assets attractive - particularly locally-listed H-shares relative to pricier domestic A-shares - which would bolster HK domestic liquidity and contribute to a potential relief rally," the report said.