Our attention has been drawn to the weakness displayed by the Shanghai Composite over the last few weeks. Of course the big question is whether or not this is just a correction of a short term overbought condition or the beginning of something far more serious. Judging from experience bear markets don’t just begin in an inverted “V” fashion. Typically there will be a breakdown from a double top or head and shoulders pattern. So perhaps the issue now is what happens subsequent to the current weakness we are observing in Shanghai.
Given that the Shanghai Comp has advanced dramatically over the last 9 months we have been expecting a pull back for at least the last couple of months so the weakness we are observing is hardly surprising. If this was the beginning of major downside what other supporting evidence would we typically look for? Well there should be contagion in other closely related markets, namely Hong Kong, Korea, and Taiwan. There should also be a sell-off in Chinese small caps and REITS. From the charts below it seems that there has been no contagion with all indices remaining close to their multi-week highs.
We don’t like to get too carried away and forecast the future or even to try and figure out what is going on in China. All we can do is be guided by the action of the market and our knowledge of how markets typically behave. We know that once a trend is set up it tends to stay in place for some time. Right now the trend is up so we are inclined to conclude that until proven otherwise Asian equity markets are likely to move higher before moving materially lower (note that the move materially lower may only come 12-18 months from now).
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