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Trade war a threat, but China in a more powerful position than before

Daryl Guppy
Daryl Guppy • 6 min read
Trade war a threat, but China in a more powerful position than before
SINGAPORE (Apr 2): It is difficult to move past the real or perceived threat of a trade war initiated by the US. For investors, the primary concern is the collateral damage and how widespread it will be. The immediate impact will be on US companies such
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SINGAPORE (Apr 2): It is difficult to move past the real or perceived threat of a trade war initiated by the US. For investors, the primary concern is the collateral damage and how widespread it will be. The immediate impact will be on US companies such as Caterpillar, Boeing and Apple, and the tourism and education industries. Any Chinese tariff retaliation will strike them first.

Chinese companies that have become deeply embedded in US markets will also be affected immediately. This includes Tencent Holdings and Alibaba Group Holding, which are listed in the US, travel services companies Qunar and Ctrip.com International, and Huawei, Haier Electronics Group and other hardware manufacturers. Investors will be hit by downgrades of the Western arms of these companies.

The ripples are far more important for local investors because tariffs and trade wars always have unintended consequences. Identifying where these consequences will hit requires careful analysis and it is too early to assemble a list.

The last time China was in this situation was in the mid-1800s. The British demand for tea was unbelievably high, in a way that seems incomprehensible to us today. China demanded that payment for tea and other exports be made in silver. Our obsession with gold is relatively recent — for centuries, silver was the prized medium of exchange as is still evident at sales payment points in Chinese department stores. The literal translation is “pay silver”, not “cashier”. Yin hang, the Chinese word for bank, is literally “silver company”.

Silver payments to China essentially bankrupted the British Treasury. The British response to this massive imbalance of trade was threefold. First, they stole tea seedlings, and Chinese intellectual property for processing the fresh raw tea leaf into tea leaves suitable for drinking. They transferred an entire industry to India so they could displace the Chinese producers.

Second, they opened the most blatant and sophisticated illegal drug trade the world has ever seen. Opium, grown in British India, was used as a substitute for payments by silver.

Third, the British and their European cohorts used military force in what we now call a regime change. The Chinese call this a century of humiliation.

Of course, this ce ntury is different from the mid-1800s, but the trade imbalance is just as real. The key difference is that China is not a weakened and corrupt state the equivalent of the Qing Dynasty. China is in a much more powerful position, and the sophistication of modern financial systems provides additional leverage.

At the top of the list is China’s willingness to finance the US spending binge. The gradual withdrawal of Chinese support for US bond issues is much more significant than titfor- tat tariffs. The cost of financing US debt would increase as would the cost of President Donald Trump’s infrastructure programme. Of course, the US could return to printing more money to finance these projects, again with global consequences for investors.

Also important is the boost the US action gives President Xi Jinping’s Belt and Road Initiative. The key foundation of this complex of policies is the redeployment of China’s foreign reserves. Tariffs and trade wars accelerate this process, in part by creating a more friendly Chinese trade zone. This is where new investment opportunities will develop. Trump’s trade war rhetoric is the sound of shifting tectonic plates.

Technical outlook for the Shanghai market

The president’s illegal tariff trade war has smashed the Shanghai Index. In this environment, it is difficult to apply technical and chart analysis because the emotion in the market is so strong and volatile.

However, past price activity can provide some guide to how the market may react in the future. This shock reaction is a clear change in the developing upside trend break. The pattern of the Guppy Multiple Moving Average (GMMA) trend test and retest pattern has ended.

The potential for a return to new uptrend behaviour has also ended. This is confirmed with the gap down behaviour and the clear close below the potential uptrend line A.

The fall below the trading band between 3,260 and 3,290 confirms that it is no longer acting as a stable support level. However, it will act as a strong resistance level for any future index rally.

These observations may seem obvious, but they are important because they show that the index collapse is not temporary. This is not a repeat of the situation seen when the market fell in February and then rapidly recovered. The January and February retreat was a change in trend behaviour. The market retreat on March 23 is the continuation of an established downtrend and a failure of breakout activity. This makes the environment much more bearish.

The trading band between 3,260 and 3,290 will now become a major obstacle for any index rebound or new uptrend development.

The potential support targets are best seen on the weekly chart. The next support level is near 3,000. This is a long term and reliable support level that started from July 2016. The market may move quickly towards this level and then find some stability. Investors will watch for the index to consolidate near this level and move sideways. Days of extreme volatility may temporarily push the index below 3,000.

There is a low probability of a rapid rebound from near the 3,000 level. However, any rebound will be treated initially as a rally rather than a trend change because the downside resistance features are very strong. In this environment, the long-term GMMA will remain well separated and this is a major resistance feature that limits any rally and makes it more difficult to establish a new long-term uptrend.

In the short term, traders will watch for fast rally-and-retreat behaviour between 3,000 and 3,260. This is a good trading environment but a dangerous environment for investors.

A fall below 3,000 has long-term support near 2,650. A fall below 3,000 is very bearish.

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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