Last week, I wrote that I was particularly excited about the prospects for China in 2024. Soon after, a Hong Kong court announced an order for property giant Evergrande Group to be broken up and liquidated.
This announcement does not affect my excitement, although it has provided new fodder for those who have been forecasting the collapse of China for the past 20 years. There were eight reasons for my excitement and four were discussed last week. I will discuss the remaining four in next week’s column because this week we need to look at the impact of the Evergrande order.
The order was not unexpected and it did not send “shockwaves through the country’s financial system” as claimed in some news reports. It accelerated the end of the rally, but that retreat was always going to happen as the index approached strong resistance levels.
The implosion of Evergrande has been a slow-moving trainwreck. The court judgement is not surprising in its conclusions or its content. Evergrande’s problems and the broader issues in the over-leveraged property sector have been around for several years, so they have been “baked into the cake”. Everyone has had ample time to adjust to the inevitable. The court only confirmed what everybody already knew.
The Chinese government could have chosen to bail out the company. Had it done so, China’s detractors would have decried the state intervention in the workings of a free economy.
When the government did not come to the rescue, the same critics took this as evidence that the Chinese economy would collapse because this was considered to be the biggest threat to the world’s second-largest economy at a time when it is also battling high unemployment, falling exports, weak consumer confidence and high local government debt.
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This type of restructuring and liquidation may be relatively new to China, but it is common practice in Western economies. There are established processes to assist in successful restructuring. There is no reason to believe that these procedures could not be successful in China.
Assets may be liquidated at a loss but liquidation does not mean the assets disappear or are dissolved like salt in water. They become assets of another company operating with a different balance sheet.
Creditors did not seek a wind-up order. Even after a wind-up, it is still possible for the company to put forward a scheme of arrangement. In some ways, the judgement is procedural and reflects the inability of creditors to agree on the restructuring terms.
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The widely anticipated Evergrande judgement is no significant barrier to China’s economic growth. It is not much more than a mosquito bite on the economy. The reality is that despite the real estate downturn, China met its 5% growth target in 2023. This year, China’s economy is still expected to grow by more than 4 %. Citi expects iron ore prices to rally to US$150 ($201) a tonne and has upgraded its copper forecasts after China pledged further support for its struggling economy. These are the reasons I remain excited.
Technical outlook of the Shanghai market
The Shanghai Index continued its plunge away from resistance near 2,920 after the market rallied in response to the easing of bank reserves. The Evergrande decision further killed the rally but did not accelerate the downtrend.
A substantial gap was developing between the lower edge of the long-term group of averages in the Guppy Multiple Moving Average (GMMA) indicator and the upper edge of the short-term group of averages. This shows that selling pressure remained strong. This gap must narrow if a true trend change is developing. This gap narrowed as the rally developed.
The long-term group of averages in the GMMA remain well separated, showing consistent selling by investors.
Traders will watch for a rebound from any dip below 2,780 to signal that it is an exhaustion move. An exhaustion move is where the candle has a long tail followed by a strong intraday rebound. This is often a sign that extreme selling has ended and that consolidation may develop. This has not developed, so investors are cautious about the strength of the rally.
Traders have improved their outlook and the short-term group of averages compressed and rose before retreating.
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A key indicator of trend reversal, which is particularly reliable when applied to the Shanghai index, is the Relative Strength Indicator (RSI) divergence pattern. It works as follows:
A trend line is drawn connecting at least two low points on the Shanghai Index. On the RSI display, a trend line is also placed connecting the low points on the RSI. The low points should clearly correspond with the low points on the index chart.
A strong divergence is when the trend line on the RSI indicator moves in the opposite direction to the trend line on the index chart. This is a rising RSI trend line at the same time that there is a falling trend line on the index chart.
This type of divergence is a very reliable pattern that indicates the market will move into a new uptrend.
A weaker divergence pattern is when the trend line on the RSI indicator is flat and the trendline on the index chart is sloping downwards. This is a good indicator of a change of trend developing, but the new uptrend breakout is weaker. Rather than a strong uptrend, the new uptrend includes rally and retreat behaviour before a new stable uptrend is established. This is the current RSI pattern.
The development of a new uptrend faces several obstacles. There are four possible resistance points which limit the ability of the market to move to the upside. The first resistance point is the previous support level near 2,780. This level has been broken on the upside. The second point is the lower edge of the long-term group of averages and the historical resistance level near 2,920. The rally is testing this area as a resistance feature. The third point is the value of the upper edge of the long-term group of moving averages, currently near 2,940. The fourth resistance point is the value of the long-term downtrend line, currently near 2,980.
Daryl Guppy is an international financial technical analysis expert. He has provided weekly Shanghai Index analysis for mainland Chinese media for two decades. Guppy appears regularly on CNBC Asia and is known as “The Chart Man”. He is a former national board member of the Australia China Business Council
