SINGAPORE (Feb 19): The Cultural Revolution is infamous for its attack on the Four Olds — old customs, old culture, old habits and old ideas. Despite extensive destruction of people and artefacts, the Red Guard rampage only forced longstanding traditions underground. Many of these traditions never disappeared and we still see them in operation when we try to get a haircut in the week before Chinese New Year. The barber shops are overflowing, as people usually avoid cutting their hair or fingernails during Chinese New Year.

Chinese New Year, or Spring Festival, is another hardy survivor of the Cultural Revolution purges. Starting the New Year on the right foot is crucial because it sets the potential for the next 12 months. Luck, health and prosperity need to know that they are welcome to hang around in the upcoming year. Columns of Chinese calligraphy, or chunlian, adorn each side of the main entrance of homes. Red packets, or hongbao, are prepared for distribution.

Another pre-Chinese New Year tradition that remains strongly in place is a house clean. This is literally a new broom and a clean sweep in preparation for the New Year. The custom is the origin of the English expression “spring clean”.

Traditionally, the house is swept, cleaned and decorated for optimal feng shui. Broken items, dead plants and all clutter are thrown out to make room for better things that are sure to come. It means an extra workload for the rubbish services as old and broken items large and small are discarded in rubbish skips across China and wherever there is a significant Chinese population.

The financial market is no different. Poorly performing stocks are discarded. Investment portfolios are cleaned out and straightened up. It is an annual rebalancing as the old is discarded and replaced by the new after Chinese New Year.

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This year, the cleanout has been particularly vicious, with a 14% fall in the Shanghai Index.

The extent and momentum of the fall were a major surprise. In much weaker market conditions last year, there was only a minor retreat prior to Chinese New Year. This year, the market was much stronger, although the very fast rise from December left room for a strong pullback and consolidation.

Unfortunately, the cleanout was given additional impetus from the collapse of the US market, with a 12% retreat in the Dow Jones Industrial Average. There was a time when the Shanghai Index was largely impervious to the antics of Western markets, but that time has changed. It is a perhaps unwelcome side effect of China’s increasing integration with global markets. It is a consequence of the internationalisation of the Chinese economy and capital markets. The pre-Chinese New Year sell-off would have taken place despite any international activity.

The cleanout was magnified by the coincidental timing of the US market collapse. A bad combination.

Some suggest that the development of an active short-selling market in the China market would help arrest the speed and extent of the fall. This certainly applies in less frenetic market retreats, as it gives investors options other than simply trading from the long side and talking losses. As the US markets showed, however, in a market panic, short selling does little to stop the rapid market collapse.

The little piles of discarded items that come with Chinese New Year traditions have a bright side. What has been discarded needs to be replaced by something new. On one level, this gives a boost to the post-Chinese New Year retail sales. It also gives a boost to the Shanghai Index after the Chinese New Year holiday. Portfolios are rebuilt and, this year, the market post-Chinese New Year sales have some real bargains on offer. Aggressive traders are already positioning themselves to trade this market rebound.

Technical outlook for the Shanghai market The Shanghai Index continues to probe for support near 3,000, a long-term historical support level that has been a significant feature of the market since 2009. The index sank below this level from 2010 to 2014, and again, briefly, in 2016. It has been a defining feature in the market for many years, though.

Investors are watching for a consolidation and rebound from this area. The Shanghai market recovery can develop in one of three ways. The first potential development is an L-shaped recovery. This is similar to the way the consolidation base and breakout developed in December.

The second potential development is a fast and rapid reversal of the downtrend. This is a very volatile and unstable reaction. It is treated with caution. The current rebound rallies are not part of this pattern. Generally, a fast V-shaped recovery starts with a pivot point low that is near a historical support level.

The third potential development is a slower development of uptrend behaviour similar to the behaviour between May and June 2017. This is the most desirable development because it shows a steady recovery.

The failure of previous support levels suggests these levels may offer limited resistance to any new uptrend development. There are three key resistance features.

The first resistance feature is the consolidation trading band between 3,260 and 3,290. This is a significant historical resistance feature.

The second resistance feature is the relatively weak level near 3,360. This level will possibly offer very little resistance when the market rebounds.

The third resistance feature is the lower edge of the long-term Guppy Multiple Moving Average currently near 3,380. As the retreat continues, the long-term GMMA will begin to separate. The wide separation in the long-term GMMA will absorb the initial market rally as investors sell into the rally.

The fourth resistance feature is near 3,440. This is the value of a long-term support-and-resistance level.

The Shanghai Index is now testing support in the region of 3,000. Traders and investors wait until after Chinese New Year before entering the market.

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.

Financial market gets annual spring clean

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