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A recovery for Chinese, US equities in the making

Charts suggest this is the beginning of a new, sustainable uptrend for stocks after trade deal

Pedestrians walking past the Bund Bull statue in Shanghai, China. The Shanghai market is developing end of downtrend behaviours and has the potential to add 48 per cent in 2020 in a new uptrend. Chinese leaders have pushed back against the more economically conservative elements, speeding up systemic reforms.

IT APPEARS that a preliminary version of a US-China trade deal will be signed sometime in the next week or so. Only a few translation issues remain to be checked and resolved.

Both sides are claiming victory, although one side is more modest in its claim than the other. The US appears to have got what it asked for and this has boosted US and global markets. In a zero-sum game, this means that China has lost what the US has gained, but the performance of the Shanghai index does not necessarily reflect this understanding. Many see the rise as a relief rally now that the trade war temperature has been lowered. The charts suggest this is the beginning of a new and sustainable uptrend.

US President Donald Trump's pressure has enabled President Xi Jinping and Premier Li Keqiang to push-back against the more economically conservative elements and speed up the implementation of systemic reforms. This includes the new Investment Law framework that came into operation on Jan 1. Details remain to be fleshed out but in principle, it satisfies many of the US demands while providing a foundation for capital diversification and greater integration with the world economy.

Consistent performance

Other apparent concessions, such as buying more agricultural produce from the US, have the benefit of fitting in with projected growing demand and may have occurred in the natural course of events. Closer examination of the results suggests this part of the recovery has been made in China to meet Chinese strategic requirements.

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This is reflected in the Shanghai Composite Index with three chart features. The first feature is the breakout above the downtrend line and the subsequent retest of this line as a support area for the current rally.

The second feature is the development of a new uptrend that incorporates two sets of rally behaviour. This is defined by a trend line starting from the Dec 3 low of 2,857. The trend line has a second anchor point on Dec 12. This is followed by a series of confirmation anchor points that hug the trend line from Dec 24 to Dec 30.

Anchor points are where price retreats to a low and then rebounds in a new rally.

The third chart feature is the breakout above the long-term resistance level near 3,040. This has been a resistance feature since July 2019, defining the five-month sideways trading pattern. The initial breakout target is near 3,120 and the longer-term target near 3,600. This gives a potential 18 per cent return in 2020. A move above this historical resistance level has a target near 4,500 or 48 per cent.

Looking at the other side of the trade war, the question is very different. It's not how high can this go, but can this uptrend continue? By any measure, the uptrend on the Nasdaq has been sustained and very rapid. From the low in 2009, it has added an astounding 563 per cent. The Nasdaq has added 23 per cent in the past five months and there is no chart-based indication that suggests the trend is weakening. The Guppy Multiple Moving Average relationships show a consistent, well-separated long-term group of averages which are usually associated with continued trend strength and resilience.

Setting a 2020 target at 10,000 is reasonable based on previous trend behaviour. However, this target - like similar targets for the Dow of 30,000 and S&P 500 of 3,500 - has no basis in chart analysis. There are no chart patterns or technical features that support 10,000 as a calculated target. Trendline analysis provides a loose guide to trend behaviour, but it is not useful as a trigger for taking profits because it is too far below the current index activity.

Recovery markets

Management of these types of strong trends is more difficult than it looks because the trend is so steep that many longer-term exit signals surrender large profits when compared with the trend peak.

Applying momentum-based indicators is also less useful because in a strong trend, they deliver consistent overbought signals. Other indicators including MACD are too sensitive and trigger false exit signals in response to minor retreats. Strong trends respond well to the buy, hold and hope approach but this is not a good investment management method.

The management focuses on identifying end-of-uptrend behaviours rather than uptrend targets. In US markets, these are rounding top and head-and-shoulder chart patterns. When these develop, investors will turn to shorter-trend management methods to take defensive profits.

The US markets have experienced a long bullish run. The ongoing focus is on the development of end of uptrend behaviours. The Shanghai market is developing end of downtrend behaviours and has the potential to add 48 per cent in 2020 in a new uptrend. Many investors will diversify into recovery markets which have room to grow. There is no doubt this recovery is made possible by China.

  • Daryl Guppy is a financial technical analysis specialist, an equity and derivatives trader, and an author. He has developed several leading technical indicators used by investors in many markets.

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