The chart of the benchmark Shanghai Composite Index (SCI) is currently showing some caution after the formation of a bearish double top in late May and mid-June. The index broke to a record intraday and historical high of 4,335.96 on May 29, followed by another surge in mid-June, but the index has failed to hold. I view this as a warning flag of potential troubles on the horizon, as the current near-term trend is negative. The index failed to hold at the psychologically key 4,000-point level.
Recent selling was triggered by efforts of the Chinese government to cool down the stock market and economy and prevent a runaway economy. There is also some profit taking and valuation concerns that have driven sellers to the exits.
The catalyst that triggered the selling in Chinese markets was the news that the country’s Ministry of Finance, in an effort to moderate the market action, would increase the stamp duty, trading stocks at 0.3% from the previous 0.1%. The aim of the duty would be to reduce active trading and speculation.
At this time, Chinese stocks listed in China remain extremely vulnerable to selling. Now, you should realize that if investors suddenly decide to cash out, it could set off a bout of selling and leave Chinese markets vulnerable. A major concern is the fact that we are seeing more unsophisticated Chinese investors rotate their capital from saving accounts into the stock markets, hoping to catch some easy gains, regardless of its dangers. Estimates suggest that unsophisticated investors hold about 70% of Chinese stocks. The surge in new trading accounts is a red flag of potential trouble ahead. The total number of stock trading accounts has surpassed 100 million in China as speculation continues to rise. This scenario is dangerous, as a mass exodus to the exits by unsophisticated sellers could drive stocks down quickly. When investors chase gains without any regard for valuation, it is risky.
The bottom line is that China will continue to be an excellent area for growth investors, but you just need to be careful at this time and be diversified in your portfolio.