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The drop in Shanghai stocks was a needed spring cleaning

  • Expect a rebound in the Shanghai composite after the Lunar New Year holiday.
  • But the Dow Jones index won't see a similar spring recovery.
A view of the skyline in Shanghai, China.
Justin Solomon | CNBC
A view of the skyline in Shanghai, China.

Markets have focused on the sudden drops in the Dow Jones Industrial Average and the Shanghai composite index. For many, the Dow fall had a benign inevitably — no need to panic. The fall in the Shanghai market, however, was seen as a warning sign, but it could actually turn into a fresh opportunity.

The Dow retreat, high-to-low, was a little over 12 percent. Let us call the move past 10 percent an overshoot, so this retreat is seen as a correction rather than a trend change.

The Shanghai index decline was 14 percent. Given the higher level of background volatility in the Shanghai market, it's fair to call the move past 10 percent an overshoot.

But that is where similarities end. The fall in the Shanghai market is not the same as the fall in the Dow, although the increasing exposure to, and integration into the global financial system has exacerbated the fall.

The Lunar New Year is a hardy survivor of the Cultural Revolution purges. One tradition that remains strongly in place is a spring cleaning of the house in preparation of the new year.

Traditionally, the house is swept, cleaned and decorated for optimal feng shui. The financial market is no different. Poorly performing stocks are discarded. Investment portfolios are cleaned out and straightened up. It is an annual rebalancing as the old is discarded to be replaced by the new after the holiday

This year the cleanout has been particularly vicious. The extent of the fall and the momentum was a major surprise. In much weaker market conditions in 2017 there was only a minor retreat prior to Chinese New Year. In 2018 the market was much stronger, although the very fast rise from December 2017 left room for a strong pullback and consolidation.

The little piles of discarded items that come with Chinese New Year traditions have a bright side. What has been discarded needs to be replaced by something new.

On one level this gives a boost to the post-Chinese New Year retail sales. It also gives a boost to the Shanghai index after the Chinese New Year holiday.

Portfolios are rebuilt and this year the market post-Chinese New Year sales have some real bargains on offer. Aggressive traders are already positioning themselves to trade the market rebound from support levels

The fall in the Dow holds no firm promise of a rebound. The cultural traditions of China suggest the Shanghai index will rebound when the market resumes trading after the holiday shutdown.

Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders, which can be found at www.guppytraders.com. He is a regular guest on CNBC Asia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe. He is a special consultant to AxiCorp.

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