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Chinese Stocks Get Chopped, S&P and USD at Support

Chinese Stocks Get Chopped, S&P and USD at Support

2015-08-20 12:15:00
James Stanley, Strategist
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Summary:

  • Chinese stocks took another hit last night as fears of economic weakness and a lack of government intervention precipitated further selling, erasing the gains from the previous session.
  • The leak of yesterday’s Fed minutes showed a dovish Fed willing to take a more passive approach towards rate hikes.
  • The S&P and the US Dollar both find themselves in support zones that could be amenable for long positions.

1. Another brutal session in China as stocks sank in the last two hours of trade. The Shanghai Composite posted a -3.42% loss while the Shenzhen Composite was off -3%. The Hang Seng Index out of Hong Kong (HKG33) sank -2.3% to a 10-month low, totaling a -19.6% move off the highs set on April 28th. A 20% contraction signifies a ‘bear market’ and the Hang Seng Index is a mere three points away from official bear market status.

But hope is not yet abandoned in Asia. The big question is what Beijing might do next to counter the economic weakness in China that’s begun to seep further into equity markets. As the sell-off in China started two months ago, many analysts claimed that the issue would likely be contained as China’s equity market was largely driven by retail traders taking on exorbitant leverage. But this didn’t account for the fact that China’s internal economic indicators already showed weakness, and the premise that a rising equity market was China’s way of ‘growing out of weakness,’ in order to enable companies access to capital markets through equity offerings.

As the stock market continued to decline, even in the face of numerous actions out of Beijing that included interest rate cuts, reserve requirement cuts, state-sponsored buying of stocks through China Securities Finance Corp. and, of course, devaluation of the Yuan investors have grown more and more pessimistic that the government will be able to quell the slowdown.

The ‘wealth effect’ that Ben Bernanke spoke about years ago is working in reverse. This is the prospect that with growing stock markets, a population is more likely to spend money which then leads to higher corporate profits, more jobs, and eventually inflation. But in China, outsized declines on stock indices are creating even more economic discomfort as the retail consumers that the country is hoping will buoy the economy for future generations are stung from margin calls and leveraged losses in equity trades.

The speculation is that China will now move to cut reserve requirements, thereby enabling banks to invest additional free capital with the goal of providing a shot of economic strength into the economy.

So it’s not doom-and-gloom in China yet, but the situation doesn’t look good.

2. Fed Minutes were Leaked, and were not very enthralling: In one of the ‘dirtier’ data releases of recent past, as in Minutes from the July Fed meeting were released a full 22-24 minutes ahead of the scheduled release, the Central Bank showed a rather dovish approach towards future rate hikes. The initial leak over Bloomberg read ‘MOST FED OFFICIALS IN JULY SAW CONDITIONS FOR A RATE RISE NEARING.’ This led traders into buying the dollar, and we saw a quick spike in USD against most major currencies. But as additional details of the minutes leaked, it became clear that this hawkish headline was misleading, showing that the Federal Reserve is concerned about factors like China, pressure in Oil, and of course, strength in the US Dollar which could eventually lead to lower corporate profits (which could lead to less hiring, inflation, etc.).

After the July meeting, and after Ms. Yellen’s Congressional testimony, expectations for the hike in September increased and continued to do so until we got closer to yesterday’s release. But as these dovish minutes made their way into the market, the US Dollar continued to sink as those expectations for a September hike got priced out of the market.

The move in the US Dollar sent the Greenback directly into that zone of support that we’ve been discussing over the past month, and this could lead to opportunities to get long the dollar. While we might not see a hike in September, the fact-of-the-matter is that the US economy is one of the few showing signs of legitimate growth.

Chinese Stocks Get Chopped, S&P and USD at Support

Created with Marketscope/Trading Station II; prepared by James Stanley

At this point, it looks like the December Fed meeting is the next logical target, if we get a hike at all in 2015. David Rodriguez had a fantastic write-up on the leak of the minutes, linked below:

http://www.dailyfx.com/forex/market_alert/2015/08/19/forex-trading-leaked-FOMC-Minutes-US-Dollar.html

3. Commodities Carnage Continues: Despite the less aggressive posture from the Federal Reserve, Oil continued to sink to a new six-year low, with WTI breaking below the $41 level. The implications of this type of move are enormous, as oil-exporting economies are feeling an even greater pinch. Economies in areas like Russia and Canada and Norway, all large exporters of Oil, are all feeling the strain as this lower oil price adds pressure on producers’ margins which, as we’ve looked at with the previous two themes, means fewer jobs, less inflation and frankly less ‘hope’ of recovery.

Oil is currently facing a supply problem, and as prices go lower, producers in Russia are incentivized to produce even more to offset those losses in prices. But as they drill more, that creates even more supply, which leads to even lower prices and the pain chain continues to go on. This is one of the reasons that one of the ‘cleaner’ trades out there right now is the US Dollar against emerging market currencies like ZAR, MXN, or CAD.

Chinese Stocks Get Chopped, S&P and USD at Support

Created with Marketscope/Trading Station II; prepared by James Stanley

4. S&P near support; buy the dip and sell the rip: One of the surest strategies in any market over the last six years during ZIRP (Zero Interest Rate Policy) has been ‘BTD,’ or ‘Buy the Dip,’ in reference to the S&P 500. The prevailing thought being that with the Federal Reserve stewarding the economy, and after the stated logic of the ‘wealth effect’ implications that higher stock prices equate to higher spending, more higher, and, eventually, inflation; stocks were essentially being supported by the largest Central Bank in the land. This is what’s created the six-year up-trend of historical proportions that have shot stocks to all-time highs in the United States.

However, since February that trend has failed to exist. While the market is caught waiting around the Federal Reserve, stock prices have oscillated within a relatively well-defined range. This isn’t necessarily a range that can easily be played both ways, but taking a one-sided bullish bias into such a situation could prove as a strong strategy.

The 2,040-2,050 zone of support on the S&P 500 has been a rigid area, offering 8-9 separate tests that have seen prices shoot higher. We’re 22 handles (S&P points) off of the 2,040 low, but watch the support zone outlined below to look for long positions in the coming days.

Chinese Stocks Get Chopped, S&P and USD at Support

Created with Marketscope/Trading Station II; prepared by James Stanley

Written by James Stanley of DailyFX; you can join his distribution list with this link, and you can converse with him over Twitter @JStanleyFX.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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