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Wombat diplomacy triggers investment caution

Daryl Guppy
Daryl Guppy12/2/2021 03:45 PM GMT+08  • 6 min read
Wombat diplomacy triggers investment caution
Beating the drums of war does nothing to restore Australian market access to China, says Guppy.
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Some Australian politicians are busy beating the drums of war and this impacts investments and businesses in China, be it direct or indirect. Defence Minister Peter Dutton is perhaps the strongest advocate with some of his recent speeches described as “warmongering” over Taiwan. This has been described as “wombat” diplomacy. Visitors to Australian wildlife parks know the wombat as a waddling bulky animal that digs holes and is bluntly robust.

It is tempting to dismiss this as posturing for purely domestic political purposes. However, the impact on investment decisions is profound for businesses that are involved in any way with China. In the past 18 months, Australia’s trade war with China has resulted in the destruction of the Australian wine industry and the collapse of commodity exports such as barley. Investment in these areas was popular because it gave access to the growing China market. However, investors in these areas have suffered greatly.

Investors seeking indirect exposure to the Chinese market have seen the Australian market share shrink. US sellers have stepped into the vacuum, taking up space previously occupied by Australia. Beating the drums of war does nothing to restore Australian market access to China and brings further threats to investments in China-exposed business.

This impact is not limited to investments in Australian companies with China exposure. The creation of a war-like environment poses a threat to Singaporean companies doing business with China because the trade environment changes.

The most significant threat is the imposition of sanctions by the US on companies doing business with China in particular areas. In particular, this includes any business activity which can be construed as supporting or enabling Chinese defence forces. This can be very indirect support, hence the ban on the sale of computer chips. But even more indirectly, sanctions can be applied to the sale of software services that also might be used by the People’s Liberation Army. Interpreted broadly, that includes the supply of office equipment, management services, accounting programs, consulting contracts and food supplies.

The US anti-China sanctions cover a very broad net. Currently, they are not applied to its full capability but as the talk of conflict with China intensifies then the net is likely to be tightened. Investors will need to assess the potential for companies to become entangled in the tightening of the US sanctions net should conflict break out.

See also: Reflections on China's market evolution over the last 30 years

Singapore and Asean are trying to steer a neutral course through this increasingly hostile and confrontational talk, often initiated by Australia. If they are not successful then the Asean region will be forced to choose sides. There is already considerable pressure being exerted to do this already. Investors cannot ignore the potential for this pressure to become a push that divides Asean members, and markets, into separate camps. If this were to happen that trade with “friends” would be favoured over trade with “enemies”. The current situation of open and free trade with all Asean partners could become constricted and that delivers significant impacts on investment options.

The largely Australian-led beating on the drums of war cannot be ignored by investors. It is a sideshow but it has the potential to boil over and inflict substantial damage to business activity in the region.

Technical outlook for the Shanghai market

See also: China cuts reserve requirement ratio to boost economy

The Shanghai Index rally broke through resistance near 3,580 but was unable to hold above this level. This was a strong rally from the exhaustion dip that tested support near 3,450. The move above the resistance level near 3,580 was not sustainable and the index fell below this level.

The initial rally quickly moved above the long term group of moving averages but they showed no expansion. This suggested that investors were not supporting the rally breakout and the subsequent retreat confirmed this. The long term group of averages is a proxy for the way investors are thinking.

The short term GMMA moved completely above the upper edge of the long term GMMA but the rally failed to attract support from investors.

This behaviour suggests that investors are not yet convinced that the rally is a precursor to a trend change. A sustainable breakout is signalled when investors move quickly to follow the rally and become enthusiastic buyers on any pullback. This investor buying support is evidenced by a rapid expansion in the long term GMMA. The continued compression in the long term GMMA underlines the lack of investor support for the rally and trend continuation.

Any breakout is limited by the long term resistance near 3,580. This resistance level is defined as the upper edge of a broad trading band for most of 2021. This is shown as line B. A sustained breakout above this level confirms the strength of the breakout and the establishment of a sustainable uptrend. The failure of the recent breakout suggests there is a high probability that the index will return to the sideways trading behaviour that has defined the market for most of 2021.

The rally has run out of momentum. It is the extent of the pullback before a fresh rebound that will define the placement of a new uptrend line. Traders and investors hoped the long term resistance level near 3,580 to again act as a support feature for any retreat and provide a base for a rebound continuation of the uptrend. This did not develop so they now look for a new rebound from the upper edge of the long term GMMA.

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Any new sustainable uptrend requires support from investors coming into the market as buyers. The evidence of this comes from an expansion in the long term group of averages. Traders may oscillate around this group of averages, but it is the expansion that proves investor support. At the moment, that support is not forthcoming.

Daryl Guppy is an international financial technical analysis expert and special consultant to Axicorp. He has provided weekly Shanghai Index analysis for mainland Chinese media for two decades. Guppy appears regularly on CNBC Asia and is known as “The Chart Man”. He is a national board member of the Australia China Business Council. The writer owns China stock and index ETFs

Chart and cover image: Bloomberg

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