U.S. Dollar, China Stocks Flash Warning Signals

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Includes: FXI, PGJ, UDN, UUP
by: Terence Chan

While I am a long-term bull, I think that moves in the US dollar and the Shanghai Composite are flashing warning signs for the global markets in general. Thus more prudent stock trading strategies are advised. Positions should be trimmed and there should be more focus on swing trading once markets reach short-term oversold levels when the correction comes.

The US dollar has been dropping on escalating risk appetite for equities, together with US Treasuries. Some would say this is also a sign of China diversifying its investments in US dollar assets (especially Treasuries) to focus more on domestic infrastructure investments as well as stockpiling of some commodity assets to support local industries.

I agree, and while this should be a long-term theme, and I believe equities is the asset class to be in long-term, chart-wise the US dollar is very much oversold in the short-to-medium term. Also, a MACD divergence has appeared (look at the thick red lines). A drop or "normalization" of risk appetite levels would allow the US and other global equity markets to correct.

On the other hand, the Chinese stock market, or the Shanghai Composite, has been on a tear since February, bottoming a month ahead of the US and rising more than 80% in a 6 month time period.

In the past few weeks however, the Shanghai Composite has lost more than 12%... a significant loss of momentum. It is also now below the 50-day moving average.

Based on my experience in the China stock market, it is pretty much like every thing else in China... it is managed or controlled by the central government. I'm not saying it's manipulated, it's just that China's stock market is still not the free capitalist environment that we are more used to.

How did China manage to lead the global rally? Through government intervention with massive $4 trillion yuan in stimulus. That was when the stock market was at the bottom. Now that everything seems a little overheated (ahead of fundamentals), including the bank lending and residential property market, expect the Chinese government to slow down its loose monetary policy. A statement from Beijing saying that it would adjust its monetary policy as needed, after saying just a month before that it would keep the same loose policy, sent shivers across a frothy market, thus the correction.

It wouldn't be unlikely that China's stock market would lead a global correction in equity markets, after leading it with furious force.

One should remember, however, not to go out shorting the markets aggressively. There is still massive liquidity in the system, and a lot of fund managers are trying to catch up with the market. I would suggest taking this time to evaluate prospective stocks and buying them on pullbacks when the correction comes.

Disclosure: No positions