Has the recent rally in China stocks hit a roadblock

Among the developed economies’ stock indices, the FTSE China A50 Index is the star outperformer since Dec 2018 global equities bloodbath where it has rallied by 30% from its Dec 2018 low.

The main reasons for China A50’s stellar performance are expansionary fiscal policies advocated by China central government to smooth the on-going economic slowdown and growing optimism that a trade deal between U.S. and China will be finalised soon that will remove existing tariffs on China’s exports to U.S.  

The action plans of the expansionary policies from the central government have been announced in the recent annual National Peoples’ Congress. To sum up, below are the key takeaways on Premier Li Keqiang’s closing press conference for the National People’s Congress on last Fri, 15 Mar 2019

• To cut Value-Added Tax by 1% on 1st Apr 2019.
• Government expenditure will be lowered to fund fiscal income shortfall from stimulus measures.
• Further adjustment on banks’ reserve requirements ratio can be tweaked to smooth economic uncertainties in 2019.
• Not in favour of flooding the economy with enormous amount liquidity which can cause long-term side effects.
• To maintain economic growth within a reasonable range, added China will rely on market to counter downward pressure. China has set a GDP growth target of 6% to 6.5% for 2019.

Since last Fri 19 Mar, the China A50 has rallied by 4% to print a high of 13064 seen on 19 Mar which is just 1.8% away from its current year to date high of 13305 printed on 04 Mar. Market participants have continued to exhibit further optimism on China “A” stocks despite that the central government policy makers are not in favour  of “flood-like” expansionary policies that can cause that an increase in financial and bad debt risks.

Thus, the recent rally in the China A50 on the aggregate has been built on a heightened optimism that the government will implement another mega 4 trillion yuan stimulus growth package during the previous slow down phases seen in 2014 and 2016 that created a positive feedback loop back into the China A50 Index that skyrocketed by close to 80%. Another irrational exuberance behaviour in the making?

Now, let’s let us look at the China stock market from a technical analysis perspective.

Relative strength of key sectors against the broader CSI 300 Index

• Based on data complied by China Securities Index Co., the current leading sector is the Information Technology that has rallied by close to 40% but its relative strength ratio has started to retreat from a major resistance in place since 2015 after a sharp run up since Jan 2019. This observation suggests that the outperformance of the Information Technology sector has started to lose strength.
• The top three sectors in terms of market capitalisations are Financials, Consumer Discretionary and Industrials. Their respective relative strength ratios are not showing any clear signs of outperformance against the CSI 300 since the start of 2019. Thus, the current rally seen in the broader stock marker are driven by the lower weightage defensive sectors such as Consumer Staples, Health Care and Telecommunication Services.   

FTSE China A50

• The on-going rally of the China A50 has started to stall at a major key pivotal resistance of 12950/13170 which is defined by the former major ascending trendline that has supported the previous secular bull market cycle from Mar 2014 to Jan 2018, the former major swing low of Feb 2018 and the 61.8% Fibonacci retracement of the previous primary downtrend from 24 Jan 2018 high to 04 Jan 2019 low.
• Price action of the Index has formed bearish daily candlestick patterns on the 12950/13170 pivotal resistance; “Shooting Star” on 04 Mar 2019 and “Spinning Top” seen today, 20 Mar 2019.
• Previous pull-backs in price action of the current up move from its Dec 2018 low has been held by an ascending trendline now acting as a support at 12570. Interestingly, the daily RSI oscillator has broken a correspond ascending trendline support from Dec 2018 with a prior bearish divergence signal seen at its overbought region. These observations suggest that medium-term upside momentum has started to wane.

Thus, the China A50 now faces the risk of a multi-week down move below the 12950/13170 major pivotal resistance. A break below 12570 is likely to reinforce a further potential down move to target the next medium-term support at 11860 (former swing high areas of 26 Jul/27 Sep 2018 & 50% Fibonacci retracement of the recent rally from 04 Jan 2019 low to 04 Mar 2019 high).

On the other hand, a clearance above 13170 invalidates the bearish scenario for a further push up towards the next medium-term resistance at 13820 in the first step (swing high of 26 Feb 2018 & 76.4% Fibonacci retracement of the previous primary downtrend from 24 Jan 2018 high to 04 Jan 2019 low).