SINGAPORE (Dec 24): China is picking up the pace of the opening up of its capital markets. This provides investment opportunities both directly in its financial markets and in foreign companies whose business success depends on China trade. It also assists in boosting production capacity. I discussed these issues at the China Academy of Social Sciences forum in Beijing recently.

In Western financial markets, the primary function of the market is to allocate risk capital. In the most basic structure, the investor lends his capital to the company by way of purchasing shares, in the expectation that the company’s value will increase. This basic structure and purpose of the financial markets has spawned many other associated activities, with more complex methods of managing and hedging risk.

China’s financial markets are playing a greater role in supporting and enabling international production capacity cooperation by increasing the size, stability and accessibility of its capital markets. The pool of capital that underpins foreign direct investment (FDI) is expanding. This is achieved by attracting foreign capital into the Chinese capital markets.

The inclusion of China in the MSCI emerging markets index is an important step. The development of stock-connect programmes between Shanghai and Hong Kong and, more recently, London, are important steps. The development of the bond-connect market further attracts international capital support for production capacity cooperation.

The internationalisation of the renminbi has progressed substantially with its inclusion as a reserve currency. Now the challenge is to transform it into an investment and capital currency. A key factor concerning this is the development of an effective foreign-currency trading market that can be used to dynamically manage currency risk for FDI.

Capital market efficiency and, hence, attractiveness for foreign capital is improved by structural changes to market regulations. Western financial markets have developed a wide range of derivative products that enable the more sophisticated management of risk.

These include the ability to trade short using derivative instruments such as contracts for difference, options, equity and index futures, foreign currency trading platforms that access the full range of currency pairs and exchange-traded funds. These derivative instruments improve the management of risk and, when available, they increase the flow of capital into a market.

One of the foundation principles of the Belt and Road Initiative (BRI) is the redeployment of foreign reserves away from the US and into countries along the Silk Road, which can multiply the benefits of new capital through economic development and expansion.

International production capacity is an essential component of the BRI. Improved financing of that capacity through expanded efficiency and continued reform in financial and foreign currency markets are important.

<strong>Technical outlook for the Shanghai market </strong>

The Shanghai Index has become less bullish over the past week. There is a cluster of resistance features that have proved to be too strong for the rally activity. The key feature now is the strength of support.

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The rally rebound has reacted away from the upper edge of the long-term Guppy Multiple Moving Average (GMMA) and the short-term downtrend line. The retreat has also moved below the lower edge of the consolidation band near 2,570. The consolidation band has support near 2,570 and resistance near 2,690. However, remaining bullish, the lower edge of the consolidation band can also be placed near 2,540, which captures the lows of October.

The Shanghai Index chart has three possible patterns and it remains too early to know which of these will emerge as the most dominant. However, one of the patterns can be discounted.

The first pattern is the GMMA 1-2-3-4 style trend breakout pattern, but this appears to have failed to develop. The broader pattern of a GMMA test and retest remains in place, but it cannot be identified as a GMMA 1-2- 3-4 pattern. This suggests there is a low probability of a strong trend breakout in the near future.

The longer-term GMMA breakout pattern of behaviour is a test and retest of the long-term GMMA as a resistance feature. These tests are shown as points 1 to 5.

The second pattern is the development of a consolidation area between 2,570 and 2,690. The 2,570 level has been broken, but there is a potential support area near 2,540, which was established in October. This broadening of the consolidation band reduces the bullishness of the behaviour, but it does not switch this to a bearish outlook.

This extended sideways pattern has continued for several months and this type of consolidation sideways movement is often associated with a change in trend direction. The consolidation activity suggests selling pressure is reducing. The pattern is often used as a base for a new strong rally breakout.

The third is an inverted head-and-shoulder pattern. Once verified, this trend reversal pattern is powerful and reliable. The upside targets are achieved in more than 80% of examples.

The left shoulder of the pattern is shown as point A. The inverted head is shown as point B. The potential right shoulder in area C develops with a rebound from near 2,570, or 2,540.

The inverted head-and-shoulder pattern is confirmed when the index moves above the value of the neckline, shown as line D. The current value is near 2,628, but traders will look for a move above 2,690 for confirmation of the inverted head-and-shoulder pattern. The long-term target for this trend reversal pattern is near 3,100.

All of these patterns are invalidated by a sustained fall below 2,570. A fall below 2,540 has the first downside support target near 2,450. Long-term historical support is near 2,400.

<i>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</i>

Opening up of China markets provides investment opportunities, boosts production capacity

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