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China's new investment law will deepen market liquidity

Daryl Guppy
Daryl Guppy • 6 min read
China's new investment law will deepen market liquidity
SINGAPORE (Mar 25): At the end of 2018, around 960,000 foreign companies had invested about US$2.1 trillion ($2.8 trillion) in China. Investment at this level is a significant vote of confidence in the Chinese economy and the future growth of China. The U
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SINGAPORE (Mar 25): At the end of 2018, around 960,000 foreign companies had invested about US$2.1 trillion ($2.8 trillion) in China. Investment at this level is a significant vote of confidence in the Chinese economy and the future growth of China. The US$2.1 trillion does not include foreign businesses that do business with China but do not have a direct presence there.

The passing of the revised Foreign Investment Law by the National People’s Congress is set to change the Chinese investment landscape again. These changes will propel China down a path that will open its capital markets at a faster rate. The pace of change has been influenced by the table-thumping tweets from US President Donald Trump and US Trade Representative Robert Lighthizer.

However, the path is not one determined by Trump. It is one that has been steadily followed for several years. Milestones on the path include the cross trading between Shanghai and Hong Kong; in the bond market; and between the London Stock Exchange and its Shanghai counterpart.

This presents a challenge to local stock markets such as Singapore, Malaysia and also Hong Kong as liquidity drains away into the larger mainland markets. There are still a few obstacles remaining, but they are rapidly being whittled away by Trump’s tweets.

Much of the focus has been on Article 22, which states that the government must protect the intellectual property rights of foreign investors and companies, and that Chinese organisations may not use administrative measures to force technology transfers. The US$2.1 trillion current investment suggests that perhaps this is not as big an issue as Lighthizer believes.

The new investment law will help smooth trade and tariff discussions and that is a short-term support for the current extended rally in the Shanghai Index.

The single most exciting development in the revised Foreign Investment Law is the way it opens the development of a structured derivative market in China. This starts with revisions to futures market trading, which followed the announcement on Dec 31 by the China Securities Regulatory Commission that opened oil and other commodity markets to futures trading.

It makes it easier to develop derivative products linked to Shanghai futures. These instruments are essential for effective hedging because they make it easier to trade short. No longer will investors and traders be limited to only trading from the long side — buying low and (hopefully) selling higher. Institutions looking to hedge and short-sell Chinese stocks are likely to enter the market in futures and increase liquidity and market stability.

This market liberalisation is a significant plus for funds that follow the MSCI Index weightings because it enables a broader range of investment strategies. This also creates the potential for a further increase in the China weightings in the MSCI indices.

Inevitably, the changes to the Foreign Investment Law will also facilitate both an opening up of currency markets and greater exposure of the renminbi to market rates. This is most probably seen in a widening of the daily trading band for the renminbi. Expanded capital market access rests on greater flexibility in the renminbi as an investment currency.

Some have argued that Trump’s trade war is a blessing in disguise for China, as it has accelerated the rate of market reform. Be it true or false, there is no denying that the new law improves market access and expands financial and currency market operations.

Technical outlook for the Shanghai market

The Shanghai Index pullback is developing. The momentum of the rally has decreased, but the strength of the uptrend has not been tested. Although not a perfect pattern, the Shanghai Index is developing an upsloping triangle pattern. It is not a perfect pattern because the upper edge of the pattern — the horizontal resistance level — is not well defined.

There are four bullish features to the Shanghai Index chart.

The first is the broad upsloping triangle pattern. This is used as a guide to bullishness rather than as a means of projecting accurate upside targets.

The second feature is the strength of trend support offered by the lower edge of the short-term group of averages in the Guppy Multiple Moving Average (GMMA) indicator. The consistent wide separation, even as the index has pulled back, suggests that traders continue to aggressively buy the index.

The third feature is the way that the uptrend line has acted as a support level. After reaching the peak near 3,130, the index consolidated and moved sideways towards the projected value of the trend line. The index has continued to use this line as a support level, and this confirms a high probability of uptrend continuation. This trend line may be tested more frequently as a support level as the index moves towards the next resistance feature.

The fourth feature is the continued strong separation in the long-term group of GMMA averages. This group shows how investors are thinking. Wide separation shows strong support for the trend. This trend support is further confirmed with the consistent separation between the long- and short-term groups of moving averages.

The next upside target for the Shanghai Index is near 3,210. This is a longer-term support and resistance level. The current pattern of pause and consolidation in the index behaviour suggests the rally will resume and reach this upside target. The 3,210 level has been a strong support and resistance feature, so there is a high probability that the index will consolidate and move sideways around this level.

Traders remain alert for the development of end-of-uptrend patterns. The most reliable of these patterns in the Shanghai Index behaviour is the head-and-shoulder pattern. There is no indication this pattern is currently developing, but traders will watch for evidence of this pattern as the index moves towards 3,210. A sustained move above 3,210 is a bullish signal for uptrend continuation.

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 more than a decade. 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.

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