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KEEPING AN ECONOMY in check hurts. China’s central bank has raised reserve rate ratios eight times in the last 12 months, with the most recent rise a week ago.
Key interest rates have been raised three times since the middle of October. Despite these measures, official inflation rose from 4.6% in December to 5.9% in January. Meanwhile, the unofficial on-the-ground inflation shows even higher price levels. The increase in food and fuel prices adds to this inflationary pressure.
Some of the inflationary pressure is due to structural cost-push, created by mandated increases in wages that are flowing through industries across the board. But inflation is also driven by shortages created by poor crop yields and global commodity speculation. Gradual renminbi appreciation also adds to this pressure, with China’s sudden surge as an importer. The country’s imports jumped by 51% in January and this growth will likely continue.
Beijing’s corrective measures are designed to pull the wood from beneath the cauldron, and they are beginning to have an impact on China’s manufacturing activity, which fell to a seven-month low. The preliminary HSBC China Manufacturing Purchasing Managers’ Index (PMI) fell to 51.5 this month, down from 54.5 in January. The flash PMI aims to be one of the earliest measures of the economy. It is based on up to 90% of responses to the survey that forms the basis of the index, usually released on the first day of the month.
At this time last year, the official China National Bureau of Statistics PMI fell to 52 in February. That was a 3.8 drop from the January 2010 figures, or pretty much the same as the HSBC PMI result for 2011. The China National Bureau of Statistics PMI for 2011 will be released in the first week of March.
We approach these results with caution as the figures are grossly distorted by the Spring Festival. The figures do not cover just the one week of official holidays — the entire economy slows in the weeks leading up to the break. The decline is seasonal, and it was at around the same level last year.
More importantly, input and output prices have increased, which suggest that inflationary pressures remain. The government has an upper inflation target of 4% and in recent months, inflation figures have remained above this level.
The bulls suggest the PMI decline is good news as it shows that the economy is cooling, just as the government has intended. The bears think these numbers are ugly, and use them as confirmation of the coming collapse of China.
The Shanghai market initially shrugged off these figures, but then reacted strongly to them and other events with a substantial retreat from the 2,940 resistance level on Feb 22.
The Shanghai Index’s retreat last week is part of the developing uptrend in the market. The degree of the retreat was large but this is consistent with the volatility in the market. During the market rise, the Shanghai index rose 2.7% on Valentine’s Day. A retreat of 3% on Feb 22 shows a similar degree of volatility.
There is a 78% probability the market will end higher a month after the Spring Festival holidays. The speed of the breakout rally cannot be sustained, so, investors expect a pullback and consolidation behaviour.
A rally is created by a rise in the index that does not include any significant index retreat. A trend is created as a series of rallies, retreats and rebounds. The retreat on Feb 22 is part of the developing trend environment.
These are the conditions necessary to confirm a new sustainable uptrend:
- A fall from resistance near 2,940. This has developed.
- This fall from resistance should be followed quickly by a rebound from a support level.
- Weak temporary support is located near 2,850. A rebound from this level confirms a fast-moving uptrend.
- Stronger historical support is located near 2,800. A rebound from this level confirms the development of a more stable uptrend.
- This type of uptrend has a lower degree of slope.
- The expansion of the long-term group of moving averages. This shows increasing investor support for the trend change. This has not developed.
- The value of the short-term group of moving averages remains above the long-term group.
A new uptrend is confirmed when the index moves above resistance near 2,940. A breakout above this level has the next upside target near 3,080.
The recent index retreat could also signal the end of the breakout rally that started from the low near 2,670 at end-January. These are the conditions that indicate the rally has failed and a new short-term downtrend has started:
- A fall below the lower edge of the long-term Guppy Multiple Moving Averages.
- A fall below the support level near 2,800.
- A fall below the value of the downtrend line with a current value near 2,750.
The large movement in the index is the normal degree of volatility for the Shanghai Index. This pattern is part of the normal development of an uptrend. A successful rebound from 2,850 will create the conditions for a new uptrend line. This will help to define the developing uptrend. (See Chart.)
