The Chinese equity market continues to lag in the New Year and is still in the red while the S&P 500 has now traded 4.5% higher in less than a quarter. Growing fears of policy tightening (see here) and potential bubbles have Chinese investors paring back their risk. As the fundamentals begin to look more murky there is a potentially foreshadowing technical development occurring in the Chinese equity market – a “death cross”.
Technical analysts are awfully creative in naming their indicators and this one lives up to the hype. The rare seen “death cross” is currently unfolding in Shanghai. As you can see in the following two charts a “death cross” occurs when a short-term moving average crosses over a long-term moving average from top to bottom. It’s generally a sign of a weakening market move. Figure 2 shows the inverse of the “death cross” – the “golden cross”, which usually foreshadows a continuing or new bull market move.
The implications for China are interesting. As we’ve previously mentioned, bubbles very rarely pop and then run back to their highs. In fact, a quick study of history’s bubbles (see here) shows that it has never happened in any of the previous major bubbles. More often, the action is sideways to down for many years as the reality of the bubble bursting takes years to set-in and the massive supply/demand imbalance gets worked off. For China, the stars are beginning to align for more difficult equity days ahead. The last time the dreaded “death cross” occurred in Shanghai was just prior to a 60% crash. While we’re unlikely to be staring at the abyss again, we could very well be looking at an early warning system of things to come later this year as a potential trade war and Chinese policy tightening put a death grip on the Chinese equity markets.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.