CHINA A-SHARES REACH EIGHT-MONTH HIGH ON STRONG VOLUME -- SHANGHAI STOCK INDEX ALSO ACHIEVES BULLISH BREAKOUT -- ANNOUNCEMENT OF SHENZHEN-HONG KONG STOCK CONNECT SHOULD BOOST INTEREST IN MAINLAND CHINESE STOCKS
CSI 300 CHINA A-SHARES COMPLETE CHART BOTTOM ... Last Friday's market message showed a big rise in the Hong Kong stock market, and suggested that mainland A-Shares might be starting to turn up as well. They did that this week. Chart 1 shows the Deutsche X-trackers CSI 300 China A-Shares (ASHR) jumping to the highest level since last December after rising above their 200-day average for the first time in more than a year. And they did so on strong volume. Chart 1 shows an "Equivolume" version of the daily price bars. That means that each daily "rectangle" is adjusted for that day's volume. Heavier volume produces a wider rectangle. Notice that Monday's upside breakout (above green arrow) was the widest rectangle in several months. That reflects heavy trading. Notice also that recent price pullbacks have occurred with thinner rectangles which reflect light trading. The volume bars along the bottom of the price chart also show bigger green volume bars (up days) and smaller red volume bars (down days). That also reflects accumulation in progress. The ASHR includes the 300 largest and most liquid Chinese stocks trading in Shanghai and Shenzhen. I'll explain shortly why the inclusion of Shenzhen stocks is important for the ASHR.
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Chart 1
SHENZHEN-HONG KONG STOCK LINK BOOSTS MAINLAND STOCKS... Chart 2 shows the Shanghai Stock Exchange Composite Index also breaking out on Monday by clearing its April peak and its 200-day average. [The SSEC ended Friday at 3108 which was 58 points (2%) higher for the week]. That upside breakout also suggests that mainland stocks have bottomed. A weekly gain for the Chinese yuan may also have contributed to mainland buying. The big news this week in China, however, wasn't about Shanghai. It was the announcement of the Shenzhen-Hong Kong Stock Connect which is to take effect later this year. A similar Shanghai-Hong Kong link was announced in 2014 and contributed to buying of mainland stocks. The latest link means that foreign investors will be able to buy stocks listed on the Shenzhen stock exchange in Hong Kong. Previous restrictions on how much foreigners can buy were also lifted. According to the Wall Street Journal, significant differences exist between the two mainland exchanges. Private companies make up three-quarters of Shenzhen stocks versus one quarter in Shanghai. Shanghai is dominated by state-owned stocks, and banks in particular. In addition, technology stocks make up a larger portion of the Shenzhen market (25%), while financial stocks account for two-thirds of the Shanghai market. That could attract more foreign interest to stocks listed in Shenzhen, and help boost A-Share ETFs like the ASHR in Chart 1 that include both Shenzhen and Shanghai listed stocks.
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Chart 2
BRITISH YIELDS ARE WEIGHING ON TREASURY YIELDS... I wrote a message on August 3 to the effect that a sharp jump in 10-year Japanese yields was hinting at a bottom in Treasury yields. Treasury yields are modestly higher since then. What's been holding them down more recently has been the drop to record lows by bond yields in the U.K. following the Brexit vote in late June. Most global bond yields are starting to stabilize which again hints that they may be scraping bottom. The top box in Chart 3 shows the 10-Year Japanese yield jumping sharply over the last month. That helped stabilize sovereign bond yields. The lower box, however, shows the 10-Year British bond yield tumbling to a record low since the end of June. That has prevented sovereign bond yields from rising. The 10-year German bond yield has stayed flat (lower box). The up arrows at the end of each chart reflects the fact that global bond yields are bouncing today. As they are in the U.S.
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Chart 3
TREASURY YIELD MAY STILL BE BOTTOMING... My earlier August message showed that the 10-Year Treasury yield was finding support near its 2012 low and in an oversold condition, which suggested a potential bottom in the making. You might want to reread that August 3 message for a longer range perspective. The daily bars in Chart 4 show the 10-Year Treasury Yield trading higher today (along with other global yields) and trading above its 50-day average. It's still way below its 200-day average and in a major downtrend. But a case can be made that Treasury yields are in the early stages of forming a bottom. That would also explain why Treasury bond prices have been selling off, along with bond proxies like consumer staples, telecom, utilities, and REITs which have become the weakest sectors in the stock market over the last month. At the same time, money has been flowing into more economically-sensitive market sectors like technology and energy. The recent rally in energy prices may also be part of the reason why bond yields are bouncing.
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Chart 4
RISING PRICE OF OIL MAY BOOST BOND YIELDS... In more normal times, the direction of commodity prices, and oil in particular, had an impact of the direction of bond yields. That because oil is viewed as an early barometer of inflationary trends. A falling oil price (along with other commodities) was disinflationary which boosted bond prices and lowered bond yields. Rising oil had the opposite effect -- falling bond prices and rising yields. Rising oil prices often prompted the Fed to raise rates to combat the threat of inflation. That's not necessarily the case now, but some semblance of those old relationships may still hold. Chart 1 shows the 10-Year Treasury yield (green line) and the price of crude oil (black line) falling together between 2014 and the start of 2016. That makes sense since falling commodities presented a deflation threat which encouraged global central banks to lower interest rates. One of the factors holding the Fed back at this point is dangerously low inflation. Rising oil prices may start to change that thinking. The boxed area to the bottom right shows the price of crude bottoming in February and trading nearly 80% higher since then (while bond yields continued to drop). A big divergence now exists between the two markets. In my view, that increases the odds that rising oil prices (and higher commodity inflation) may start to boost bond yields.
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Chart 5
CRUDE OIL MAY BE FORMING MAJOR BOTTOM... Yesterday's message showed the Energy SPDR (XLE) rising to the highest level in a year in anticipation of higher energy prices. Those higher prices are already in the inflation pipeline. The black bars in Chart 6 show Light Crude Oil (WTIC) (through Thursday) moving closer to the "neckline" drawn over its October/June highs. A move above that resistance line would complete a "head and shoulders" bottoming formation that started forming last August. [A H&S forms three bottoms with the middle "head" (in February) lower than the two surrounding "shoulders" (last August and this August). That's a very bullish pattern. The shaded area plots the CRB Index (of 19 commodities) to show that most commodities are also rising. That's potentially inflationary. If bond bulls aren't worried yet, they will be if crude oil achieves a bullish breakout. That would also catch the attention of the Fed.
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Chart 6
TELECOM AND UTILITIES TURN DOWN ... Another sign that investors are turning negative on the bond market is the fact that they're selling bond proxies like telecom and utility stocks. Charts 7 and 8 show utility and telecom ETFs falling below their 50-day lines. Their relative strength lines (above charts) are also falling. That's a sign that investors are abandoning dividend paying stocks that benefit from low bond yields. I suspect those sellers don't expect bond yields to stay low for much longer. I also suspect that some of that money is moving into energy stocks which usually rise when bond proxies fall. Falling bond proxies suggest that investors expect lower bond prices.
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Chart 7
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Chart 8
OVERBOUGHT S&P 500 CONTINUES TO STALL... My final paragraph from last Friday suggested that the S&P 500 rally was stalling due to a short-term overbought condition. That's still the case. The top line in Chart 9 shows the 9-day RSI line failing to confirm the recent move to new highs in the SPX and starting to roll over. A drop below 50 would signal more selling. Daily MACD lines (below chart) have been negative throughout August. I suggested that a pullback to its August low wouldn't be surprising. That would still keep it above its 50-day average and more significant support along its June high. Seasonal factors may also encourage some profit-taking as we move closer to the more dangerous month of September. So might any hint of higher interest rates.
