(May 13): Business is about trust and that is built in good faith. US President Donald Trump’s most recent tweet that tariffs on Chinese goods will be doubled is evidence of a breach of trust and good faith. This creates problems for those who have invested in some of the US’ most profitable companies, whether they be directly linked to China trade or not.
The impact on the Apple supply chain is significant. The impact on soybean growers in the American Mid-West is not eliminated despite the farm-gate subsidies they receive in compensation. The US soybean market is being supplanted by other producers who are supplying China’s needs.
It is comforting to believe that this lack of trust and good faith is something confined to the US-China relationship, but this behaviour impacts every US trade relationship, and our investment strategies must take this into account. The collateral damage from this trade war extends beyond the obvious impact on the Shanghai Index.
A recent study looked at the tariffs on Korean washing machines. These tariffs of 50% were imposed in response to a complaint from Michigan-based Whirlpool about competition from South Korea’s Samsung and LG Electronics.
The study concluded that US consumers spent an additional US$1.5 billion last year on washing machines as a result of higher prices made possible by tariffs. Domestic US manufacturers raised prices on their washing machines by a range of 5% to 17% to just below the price of the tariff-stricken imported machines.
Tariffs reduce, but do not eliminate demand for products. China’s economy contributes 27% to world economic growth, against the US’ contribution of 12.3%, according to calculations by Bloomberg. This suggests that the balance of economic weight is in China’s favour. Pullbacks in the Shanghai Index may provide a longer-term buying opportunity.
The exceptions are those companies that are part of the US supply chains or largely dependent on exports to the US for their revenue growth. There must also be growing concern about the status of Chinese companies listed on US exchanges. They are not immune from retaliatory action from disgruntled US investors or regulatory constraints. Investors may consider protecting profits.
The opportunities are found in companies involved in the economic expansionary activities foreshadowed by Chinese President Xi Jinping as part of the Belt and Road Initiative. Trump talks of product substitution — buy American rather than Chinese. Xi is developing economic substitution with domestic economic growth and growth fuelled by BRI developments.
Investors can invest directly in China--listed companies, or in Singaporean companies that are part of the BRI logistics and services chains. These investments are immune from random US tariffs. However, the immediate impact on the Shanghai Index has been substantial.
Technical outlook for the Shanghai market
The retreat in the Shanghai Index confirms that the most powerful and reliable technical signal in the Shanghai Index is the Relative Strength Indicator’s bearish divergence signal. The proximate cause was Trump’s tariff tweets, but the retreat was already presaged by the RSI divergence signal. The speed and depth of the retreat was determined by other factors.
Conversely, the most reliable indication of a change from a downtrend to an uptrend is the RSI bullish divergence signal and it is this signal that traders are watching for as the index falls. This type of reversal signal develops over several weeks and requires a rebound, retreat and rebound pattern to develop in the index.
The bearish features of the retreat are confirmed by the rapid change in the Guppy Multiple Moving Average relationships. The short-term GMMA has plunged below the lower edge of the long-term GMMA. This is a savage selloff by traders. The long-term GMMA has also turned down but not yet begun to compress. This suggests that investors are more cautious in their reactions. They have not joined the selling with the same enthusiasm as the traders. This suggests they will react more positively to any rebound rally and come into the market as buyers.
The Shanghai Index gapped below the recent support level near 3,040. The next support level is near 2,820. This was an important resistance feature in 2018, so it may act as a strong support level as the market retreats. Traders watch for evidence that the index can consolidate near this level. There are early signs that the market fall has slowed, and this increases the potential for support consolidation to develop.
The area between 2,700 and 2,820 was a broad trading band during 2018. Traders and investors are alert for this trading band to again act as a support and consolidation area. Activity within this consolidation area may develop into the conditions for an RSI bullish divergence pattern. Traders will remain alert for this pattern development.
Daryl Guppy is an international financial technical analysis expert and special consultant to AxiCorp. He has provided weekly Shanghai Index analysis for mainland Chinese media for more than a decade. Guppy appears regularly on CNBC Asia and is known as ‘The Chart Man’. He is a national board member of the Australia China Business Council.
