The Shanghai Composite is Breaking Down
A big reason for the violent market crash on Wednesday and Thursday – where the Dow Jones lost close to 1,400 points – was concerns over weakness in China.
China’s government had to reduce reserve requirements as a monetary stimulus last week and the markets here and in Asia took it as a sign that the trade war was starting to impact China’s economy. That’s not good for the global economy and markets.
Trump may be doing the right thing, generally, in confronting China over its unfair trade policies and technology theft… but wrecking the largest growth economy with massive debt and leverage? That’s dangerous.
I talked about a line in the sand in China and showed this chart on August 20. The second bubble burst in late 2015, right in line with my new bubble model, with a 45% crash within the first three months. It was ultimately down 49% before a long “dead cat bounce” into March of this year. That is rarely a good sign.
Here’s that chart again, updated…
My warning was that a break of the early 2016 low, around 2,640, could signal the next move down with a first target of 2,000 to follow shortly and then an ultimate target of the 2007 lows of 1,000.
Well, last Thursday the Shanghai Composite fell to 2,540 intraday – 100 points or 3% below the line in the sand.
It bounced a bit into Friday, back to 2,606.
It was down today and closed at 2,568, still well below the breakdown point.
Of course, it’s still possible that this could just be a short-term blip engineered by traders to blow out short positions and trigger stops for investors…
If the Shanghai can break convincingly back above 2,640 soon, then maybe this scare is over for now.
But, if it continues down, it would be a sign that the markets continue to worry about China’s growth and that would likely weigh on U.S. and emerging market stocks.
Will the Correction Continue?
The market started correcting just over a week ago. The break up in 10- and 30-year Treasury bond rates was the first catalyst (something I’ve been warning about… I see rates going as high as 4.0% and 4.3% respectively in the months ahead).
That and further weakness in China are the two factors that could cause the late September peak in stocks to turn into a steeper downturn in the next few months… and more strongly suggest stocks have already peaked.
But U.S. stocks held their channel upwards at 2,710 on Thursday. And this correction thus far is not quite as steep or deep as the one we saw in February. We’ll need to see more red in the markets to raise the risks that this bubble has already burst.
If this correction remains contained and we don’t see a 30% to 40% crash by early January, then my second scenario becomes much more likely. Remember, that’s where we would see a top in late 2019 around 30,000 on the Dow and 3,300-plus on the S&P 500.