The Chart Foretelling the (Nasty) Future of Chinese Stocks

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When we look at ways of describing the present, it’s often worth going back to the past for clues. Finding parallels between where we are and where we’ve been can tell us where we’re going next.

Of course, at The Daily Reckoning, we’re interested in the direction of markets. From commodities to stocks, we’re always on the lookout for signals that could tell us where markets are heading.

When it comes to stocks, it’s fair to say the last six months have been anything but kind to investors. The global market rout, which kicked off in China in mid 2015, saw equities end the year on a low note.

As a result, the ASX finished the year 2.4% lower. And while the start of a new year offered renewed hope, reality has been sobering. The New Year hasn’t proved any kinder to markets. Already the ASX is down 7% in the first two weeks of trading. In early Thursday trade the ASX is down 2.5%, following massive selloffs on Wall Street overnight.

But Aussie investors have hardly had it the worst. China has the unwanted distinction of leading the way, with the Shanghai Composite (SCI) down 14% since the turn of the year.

Rightly or wrongly, investors are worried. They question whether this slump is a mere blip or the start of something much bigger.

So are there any signals which could tell us where things go from here?

Well, as it happens, there might be. Deutsche Bank have compiled a chart we thought was too interesting not to share. Have a look.

nasdaq

Source: Deutsche Bank/Bloomberg Finance via Zerohedge

The chart itself is fairly self-explanatory.

The dark blue line shows the performance of the NASDAQ between 1999–2001. The light blue line is the performance of the SCI between 2014–15. So what are we to make of it?

You’ll notice straight away the lines follow a very similar path. Eerily parallel, in fact.

But what does this actually tell us? Is it just a case of finding patterns where none exist? Maybe it is nothing. It could just be a coincidence. But the parallels are striking, you’ll agree.

Or perhaps they’re more than that. We could also consider the idea that investor sentiment is similar across history. We’re all human beings, and we all act, and react, in similar ways. Regardless of time or place, people are subject to the same decision making process when placed in certain circumstances. We buy when things seem prosperous, and sell when the gloom descends. When these dynamics line up, it doesn’t matter whether we’re in China or the US, the results are the same.

Could it be that what we’re seeing here is analogous because history is rhyming, if not repeating? Not only is the rise of each market more or less on par, but so is the decline.

The NASDAQ predicted that China’s market rout would continue even when it was stabilising late last year. Just as the NASDAQ experienced in 2000, another correction was just around the corner.

Jim Reid, the Deutsche analyst who came up with the chart, writes:

Both saw an initial sharp 2–3 month fall from their peaks followed by a quarter or so of stability. The NASDAQ then started to fall sharply again and Chinese equities seem to have started a similar trend on a similar timeline. While it’s hard to read too much into such a chart’s predictive power, it’s a reminder that when bubbles pop they can pop hard and carry on falling for some time. Both Oil and Chinese equities are currently victims of such a trend.

If this chart foretells what happens next, the first six months of 2016 will be filled with plenty of discomfort. The NASDAQ slid all the way up until April before the losses came to a stop. Following this, it stabilised again, regaining some of its losses.

So is it going to be more of the same for the SCI?

Well, already Chinese stocks are off to a stinker in January. The SCI is down 14% in the first two weeks of trade alone. Now, you may notice that the NASDAQ actually spiked in January. But there’s a good reason for this. And it all revolves around the timing of monetary easing in the US.

How rate policies rescue stocks

As it happens, the NASDAQ’s January gains coincided directly with a reversal in US interest rate policy. January was the start of monetary easing on a monumental scale. The Federal Reserve proceeded to cut rates by 0.5% in every single month during 2001.

With borrowing costs tanking, it paved the way for a wave of new credit to swamp the system. And we all know where that tends to end up…

Obviously, the NASDAQ got an early reprieve in January on the back of the first rate cut. Yet considering the market then decline sharply, investors were left unconvinced. Maybe they thought the Fed wasn’t serious enough about easing lending. They needn’t have worried.

With the Fed slashing rates left and right, there was only ever going to be one outcome. As sure as night follows day, the NASDAQ started to rise again in April. The Fed showed they were serious about supplying the economy with credit in the months leading up to April by slashing rates as they did. And, just like junkies waiting for their next fix, investors poured back into stocks.

To relate all this back to China, we’re seeing very similar things play out. Not just in stocks, but in the way Chinese policymakers are slashing rates too.

China’s official interest rate, currently at 4.35%, has plunged by 2% since last year. If the US example circa 2001 is anything go by, markets should ready themselves for much more.

Keep in mind that US interest rates fell by 4%, to just under 2%, in just 12 months. The Chinese, meanwhile, have already lowered rates by 1.1% since February last year. With the economy still reeling from a slowdown in economy activity, we can expect further cuts soon. We didn’t actually need the NASDAQ parallel to predict this. It seems almost a given at this point that China will continue to ease credit. Policymakers have said as much.

But if China slashes rates by the same margin the US did in 2001, that would leave them with a cash rate at close to zero by December.

So that’s one potential outlook for the rest of the year. Much, much lower rates in China. Much more pain in the first half of the year for global equities. And a few occasions where it looks as if the markets are stabilising, but aren’t really.

In other words, another year of kicking the can the road. Only problem is, when China can’t ease credit anymore, the chickens will come home to roost. That won’t be pretty for anyone.

Mat Spasic,

Junior Analyst, The Daily Reckoning

PS: What we’re seeing playing out across global markets today is more than just a correction. According to The Daily Reckoning’s Vern Gowdie, we’re at the beginning of the end in the next major financial crisis.

Vern is the award-winning Founder of the Gowdie Letter and Gowdie Family Wealth advisory services. As one of Australia’s Top 50 financial planners, Vern says the next crisis is already in motion, and that it can’t be stopped.

He warns that stocks won’t be the only market that crashes when things blow up. There’s another multibillion dollar market that’s poised to collapse when the credit bubble pops.

Australia has gone through two credit bubbles in its history. The third, and latest, has built up over the past 65 years. When it pops, the impact will leave a lasting mark on the global economy. One that makes the 2008 financial crisis look like child’s play.

The fallout of this crash could severely damage your wealth. Yet, with some preparation, you can safeguard your wealth from the worst effects of the coming crisis.

Vern will show you how to do this, and more, in his brand new report, ‘Global Financial Crisis 2016: 3 Crisis Scenarios, and How They’ll Impact Australia’. To get your free copy today, click here.

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