— by special guest columnist Anthony Jasansky, P. Eng.
The growing influence China now has on the global economy can easily be seen through the increasing impact the Chinese stock market has on other global markets. Visual evidence of this can be observed by comparing the trend of Shanghai Composite against the S&P 500 over the last two years of trading. This period included one of the most devastating bear markets of the past 100 years, followed by a rebound of comparable historical extremes.
The Shanghai Composite and the S&P 500 made almost coincidental all-time tops in October 2007. Then, as the descent rate of the bear market accelerated, the Shanghai Composite became the “leader,” breaking to new lows ahead of the S&P 500. Composed of more speculative stocks, the Shanghai Composite percentage losses were also much larger.
This downside leadership came to an end on October 28, 2008, when the Shanghai Composite reached a two-year low, 73% below its October 2007 top. While the S&P 500 had not broken below its previous lows, it subsequently resumed the decline, making a new 12-year low on November 21, 2008. As we all know by now, the S&P 500 finally bottomed out in March 2009, five months after the Shanghai Composite hit bottom.
In hindsight, the Shanghai Composite has reestablished its leadership role for the subsequent market rally by bottoming five months ahead of the S&P 500 and other markets of developed countries. The Shanghai Composite’s rebound started early and led the S&P 500 higher.
That brings me to the trading in the recent three weeks when the Shanghai Composite suffered a 20% setback, while the market indices of developed countries managed to eke out even further gains. While it is not certain that the Shanghai Composite will retain its trendsetting power, its dominant role in the last two years is worth taking into consideration at a time when the NYSE and the S&P 500 are grossly overextended and ripe for their own sizeable setbacks.
The consensus of the three groups of market indicators we track are currently at a “dead neutral” zero percent. That standing masks the sharp disparity in standing of the three groups. As normally expected for a group primarily composed of trend-following indicators, the Technical group is at a bullish +34%.
As I had noted on previous occasions, trading volumes have been suspect for much of this market rebound. In addition to “flash orders,” there are also days when trading in a handful of NYSE-listed “corporate welfare bums” (AIG, Bank of America, Citigroup, GM, etc.) can account for 25%-35% of the total NYSE trading volume and even for a large part of the upside volume.
Our second bullish group, at +60%, is composed of indicators that are based on various yield spreads. As long as the Federal Reserve can supply accommodative monetary policy for the credit markets, this group will continue to be “stuck” in a bullish mode.
In contrast, the heavily weighted Sentiment group (which measures how bullish or bearish market watchers are) is now at a very bearish -48%. Including mostly contrary indicators, its signals have a good track record in projecting upcoming market trend reversals. As a result, I expect rocky markets in September and October, two months with more than their fair share of large market sell-offs.