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VIDEOLook to China for the Future of US Equity Markets and Oil
As long as China remains weak, it's unlikely that equities or global commodities will show any strength.
Risk assets, despite an early morning rally attempt, fell again to finish at the lows for the month. The PowerShares DB Commodity Index Tracking Fund (DBC) has lost nearly 12% since peaking on January 6. Meanwhile, the S&P 500 is down almost 80 points (or 6.5%) in the last eight trading sessions. Viable short-term support for DBC is almost more than 5% lower from here at 21.36; S&P support comes in nearly 4% below Friday’s close, beginning around the 1,030 level. Yield on the benchmark 10-year US Treasury closed January at 3.61%, just off the month’s low at 3.58%. Yield support remains intact at 3.55%. The 10-year note has rallied nearly 6% in price after closing at its worst level (3.84%) on January 4 -- the first trading day of the year. Dollar strength, particularly versus the euro, continues to fuel gains in the US Dollar Index (DXY). Since closing at 76.78 on January 14, the index is up more than 3%. DXY is in a nice uptrend since its November 25 low (74.26) and appears headed toward our short-term target (highlighted in Friday’s report) near 80.50.
Safety trade dominated Friday’s action after early (modest) rally in risk assets
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Market Internals: NASDAQ
(Figures are rounded)
Chart of the Day: The iShares FTSE / Xinhua China 25 ETF
First, find the leader: China, the S&P 500, and Crude Oil
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- ThirdWave's look at the Chinese stock market begins with an illustration (see chart above) of just why China is so important, even for investors without any exposure. We’ll use the iShares FTSE / Xinhua China 25 ETF (FXI) to represent the Chinese stock market.
The chart above shows the FXI versus both the S&P 500 and crude oil futures on a weekly basis going back some four years. Evidence appears to suggest that China has taken a leadership role versus the S&P and crude oil since 2008.- First, China put in a bottom in late 2008 and did not set new lows while the S&P and crude oil were putting in their ultimate low prints in the first quarter of 2009.
- More recently, China peaked (for now) in December and made a lower high in January, while both the S&P and crude oil only just put in their tops in January.
- At the very least, it can be said that China’s market is definitely worth watching as it may provide clues as to the future direction of US equity markets and oil. With that established, it’s time to closely examine the chart of FXI.
Clearly leading, where is China heading?: the iShares FTSE / Xinhua China 25 ETF
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- To begin, FXI appears to be in a wave 4 correction with possible downside to $31.11. On the way down to that level, FXI could stop and bounce a bit at the $36.81 area.
- The rationale for the $31.11 target is as follows. First, it's the closing high of wave 1, which in Elliott Wave Theory can't be violated by the lows of wave 4. Additionally, that level represents horizontal line support created by five separate instances of changes in direction, breakouts, or breakdowns. Finally, that level appears to be where the uptrend line for FXI will be coming into play.
Looking at relative strength, the RSI for FXI isn't yet reading oversold. My guess is that by the time FXI trades down to the $31.11 area, the RSI will reach the type of extreme oversold readings that would make buying FXI a low-risk trade. - The long-term picture for the FXI still remains bullish, as this wave 4 correction will be followed by a wave 5 move higher. But, the short-term outlook is for more downside, possibly as much as 15% to 20%.
- If the recent pattern of Chinese leadership holds, then risk assets in the US could still be vulnerable. S&P support near the 1,030 level and DBC support at 21.36 would almost certainly be put to the test if China (FXI) falls another 15% or more.
- At the very least, China provides some strong clues as to the future directional bias for US equities, as well as global commodity prices.
Strategy: Short-term bounces may occur, but it appears that there's as much as another 20% of downside possible for FXI. Use any bounce as an opportunity to raise cash or get short of Chinese stocks. Also, as long as China remains weak, it is highly unlikely that we'll see any strength from US equities or global commodities. So, rallies in either of those marketplaces should be faded, too.
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