SINGAPORE (July 2): Trade what you see or trade what you believe? It is a key question facing investors as the US-initiated trade wars continue to develop. Our focus is on China, but the same questions apply to investors with exposure to European and US stocks. Nobody wins in a trade war, but some lose less than others and that result is a poor measure of success.

China is rapidly developing alternative markets. The Belt and Road Initiative is a central part of this strategy. How companies can work with this strategy is the subject of the One Belt, One Road conference to be held in Darwin, Australia, in July, where experts from China will discuss the issue. In contrast, the US seems intent on reducing the markets in which it can operate easily as one-time friends Canada and Europe are faced with a tit-for-tat trade tariff response. It is probably only a matter of time before Australia is subjected to presidential tariff whims.

Investors are watching the US companies that are more exposed to Chinese retaliation. This includes Boeing and major US car manufacturers. China is by far the largest export market for the US, larger than its own domestic market.

With almost 40 years of US corporate investment in China, the subsidiaries of US multinationals based there are doing a roaring trade selling goods and services to Chinese consumers. China is the profit centre for the likes of General Motors, Nike, Starbucks, Ford Motor and other iconic US companies. Reduce or strip out their core profit centres and these companies will be severely impacted, along with your investments in them.

In 2015, US multinational subsidiaries based in China made a total of US$221.9 billion in sales to domestic consumers. More recent figures are unavailable, but it is safe to assume this number is growing rapidly rather than shrinking.

The value of these sales of US products and services inside China far exceeds the value of US direct exports to China. These sales do not show up in the trade balance or the current account, but they are part of the larger aggregate economic relationship.

These domestic in-country sales are directly imperilled by the US trade war policy, so investors need to be aware of this hidden impact on the profitability of the US parent company. The impacts also spread all the way down the supply chains, which are often traced back to countries within our region. The simplest example is the chip supply chain that will impact Taiwan and Japan. Companies such as Apple build their base profits on cheap assembly of components imported into China. The assembled iPhone is sourced from China, but many of the components are sourced from outside of China.

China, too, is hit by collateral damage that comes from the trade war impacts on the US companies operating there. The goods and services sold in China are produced by an army of around 1.7 million people employed by US subsidiaries in the country. Many of them are skilled professionals who, if necessary, will find work with European competitors.

While Beijing may respond with formal trade measures, there is a real danger of an informal nationalist backlash. The sales of these companies could be hit, not by official regulatory action but by consumer boycotts.

Trade wars, by their very nature, are irrational because the complex trade relationships are not the simple dichotomy depicted by US President Donald Trump. Navigating this complexity, and the raft of unintended consequences, is a difficult task for investors, so it is more profitable to trade what we see in the market reaction rather than what we believe to be the facts.

Technical outlook for the Shanghai market

The Shanghai Index rapidly reached the first support level near 2,880. There is no evidence of consolidation near this level, so the next support level target is near the 2016 lows of 2,650.

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Determining when the market has stopped falling and is developing a consolidation behaviour depends on two features: the strength and character of the downtrend; and the behaviour of the index as consolidation develops — because this consolidation forms the base for any future uptrend development.

The strength of the downtrend is shown by the behaviour of the Guppy Multiple Moving Average indicator. The long-term GMMA is well separated. This shows considerable trend strength and a steady trend with low probability of rapid change in trend direction. Any rebound rally is temporary.

The short-term GMMA is also widely separated. This shows no immediate evidence of slowing. Bearish strength is also shown by the way the index clusters around the lower edges of the short-term GMMA.

The current wide but steady separation between the two groups of moving averages is usually associated with strong trend behaviour, although individual trading days may have large daily trading ranges from high to low.

The strength of the downtrend makes it difficult for consolidation to develop. Investors watch for consolidation to develop near historical support levels. The first historical support level is near 2,800, but the index is not pausing near this level. This weak support level was created in May to July 2016, but it did not act as a significant level in the years before that.

The strongest support level is near the index lows reached in 2016, near 2,650. Investors watch for five features:

<ul><li>First, a pause and a rebound from the 2,650 level;</li><li>Second, a reduction in the daily volatility of the index. This consists of smaller moves between the high and low of the day. This signals the development of a consolidation pattern;</li><li>Third, the appearance of more up-days, where the index rises. This is not a new uptrend, but it shows that buyers are returning to the market;</li><li>Fourth, the behaviour of the GMMA averages. This includes compression in both groups of averages, because this shows a development agreement about price and value; and</li><li>Fifth, a sustained successful testing of the 2,650 level as a support level. This means the index stops falling and begins to move sideways.</li></ul>

These are the features that signal market consolidation and the potential for a new uptrend to develop. Investors wait for these conditions to develop.

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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