China Syndrome
10/23/18

●Chinese government pledged to support economy, markets

●Yesterday China’s stock market posted its biggest gain in three years


 

Just as the grass sometimes looks greener on the other side of the fence, stock-market returns often look bigger—check that, smaller—when viewed through the rose-colored glasses of rallies past.

There are probably plenty of US investors, for example, who have been put on edge by 2018 returns that, although positive, pale in comparison to 2017’s fat gains.

Forget that the tech sector is still up more than 10% on the year, and health care and consumer discretionary are pretty close to that threshold. When you’ve had an S&P 500 (SPX) that’s more than tripled since its 2009 low and double-digit returns in five of the past 10 years, people get pretty antsy pretty fast.

China’s stock market may offer a therapeutic reality check for US investors. The Shanghai Composite Index (SSE), which hit its all-time high in 2015, has been in a bona fide bear (panda?) market for a while, and last Wednesday dropped to -30% on the year. ‘Nuff said.

Baidu (BIDU), 4/27/18–10/22/18. Baidu (BIDU) daily price chart. Searching for an up move.

Source: OptionsHouse

Some high-flying Chinese tech names traded in the US, such as Alibaba (BABA) and Baidu (BIDU), held their ground for a good chunk of this year before accelerating to the downside in recent weeks. For example, search engine colossus BIDU pushed to an all-time high of $284.87 in May before falling around 32% to last Thursday’s close of $191.88 (chart above).

Before even addressing the issue of whether such stocks have fallen to a level that makes them attractive as long-term plays, let’s get to what happened yesterday: The biggest daily jump in the SSE (+4%) in around three years amid news that Chinese authorities would support the markets and the economy in the face of recent weakness.1

Baidu shares enjoyed the ride, gaining more than 2.5% in the US trading session and bouncing off the nearly 14-month low they made earlier in the month. From China’s perspective, the announcement may have served its short-term purpose—stop the bleeding and instill some confidence. Traders will gauge whether it’s a one-day phenomenon or the latest opportunity to short Chinese equities.

The weekly BIDU chart below shows the most recent downswing broke below the support implied by multiple 2018 swing lows, and took the stock into the range of the massive 2015-2017 triangular consolidation.

Baidu (BIDU), 5/18/15–10/22/18. Baidu (BIDU) weekly price chart. Held above recent lows.

Source: OptionsHouse

Even if Chinese stocks give back some of yesterday’s gains in the next day or two, some traders may anticipate at least a shorter-term bounce and test of that recently broken support level (around $206.50–$208). Unlike in the US (or Canada, or Britain…), the Chinese government tends to lay its hands fairly heavily on the levers of its economy when it feels the need.

Also, even before yesterday’s news, the pullbacks in BIDU and stocks like it had reinvigorated the chorus of voices claiming these stocks were at attractive longer-term levels,2 although it’s good to remember that some of those voices were saying similar things earlier in the sell-off.

But that’s about investing. Traders won’t risk overstaying their welcome in a trade, either way.

Today’s numbers (all times ET): Richmond Fed Manufacturing Index (10 a.m.).

 

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1 Bloomberg. China Brokers Lead Biggest Rally Since 2015 Amid State Support. 10/22/18.

2 Barron’s. Alibaba, Tencent, and Baidu Are Down, Not Out. 10/19/18.