Chinese Stocks Break Years-long Critical Support Line

Before showing some rather unpleasant looking charts it’s important to keep in mind the following two items. First, the domestic Chinese stock market is still by an large closed to foreigners. Extremely large institutional investors can only purchase Chinese shares through convoluted means and then the sale of those shares takes an inordinate amount of time. Said differently, foreign investors do not own domestically traded Chinese stocks in any meaningful quantity. Secondly, and following onto the first point, the Chinese stock market is driven primarily by domestic retail investors and the government mandated actions of large state owned enterprises. These two points combined make the Chinese stock market an interesting case study, but severely lacking in information content, at least relative to most stock markets. What the Chinese stock market is, is a barometer of liquidity in the domestic Chinese economy. This is an important enough trait and in our view the primary reason foreign investors should not ignore Chinese stocks all together.

That said, Chinese stocks look pretty terrible at the moment. As of last night the CSI 300 broke what we would consider to be a critical support level that goes back almost a decade. This latest decline has reversed much of the bubble blowoff we saw from late 2014-2015, but history suggests further decline could be ahead. The rule of thumb for bubbles is that they end up retracing 90% of the gain over time. That is a pretty blunt rule and not one we’d take too seriously, but if it comes to pass that would imply 20-25% further downside from these levels.