China view: Dollar risk and sanctions
Much attention among the US and its allies has been focused on the Chinese threat to Taiwan. The level of concern is not necessarily reflected in Taiwan newspapers, but it is leading to a lot of sabrerattling which is of concern with regard to the smoothness of trade relationships.
The situation is part of a broader picture of confrontation with China. There was some expectation that the new President Joe Biden would adopt a more strategic and diplomatic approach to America’s engagement with China. This more diplomatic approach to China has not eventuated and that raises several concerns for business engagement.
Despite the headlines, front and centre of these concerns is not Taiwan nor whatever is or is not happening in Xinjiang. Front and centre is the increased willingness of the US to abuse its hegemon position with a variety of sanctions. These were a clumsy weapon favoured by former President Donald Trump, who took the weaponisation of the US dollar to new highs. Once reserved for the most serious of cases, usually backed with United Nations consent and agreement, the use of dollar sanctions became a direct tool of US foreign policy, sometimes in defiance of the UN.
Biden has continued with this abuse of the dollar’s vaunted position as a global reserve currency. Countries that hitched their currencies to the value of the US dollar were always held hostage to changes in US monetary and fiscal policies, and the renminbi was no exception.
However, the threat of exclusion from the dollar-denominated settlement system for a variety of reasons directly related to US foreign policy objectives is a beast of a different character. This is a threat to the continuation of business and the ability to execute cross-border trades. US domination of the Belgium-based Swift system has been eroded by China’s recent joint venture with Swift. The development of China’s sovereign digital currency stands ready to act as a bulwark against further weaponisation of the US dollar.
This represents a significant challenge for business because decisions will need to be made about continued involvement with Swift and dollar transfer, and involvement in alternative settlement processes built around an expanded China sovereign digital currency.
That is one side of the sanctions coin. Trump showed a propensity to impose unilateral sanctions on selected countries in defiance of any UN position. Iran is the most obvious case, but similar unliteral sanctions decisions were applied to other countries disliked by the US.
The potential for US-backed individual sanctions on products the US dislikes has an impact on supply chains. The use of cotton from Xinjiang and the new assertion that some components used in solar panels are sourced from Xinjiang are all building towards industry- and productspecific sanctions or bans. Our task is not to debate the merits or otherwise of these unilateral sanctions, but to assess the impact on listed companies in which we hold investments.
In a worst-case scenario, a product ban on cotton disrupts the economics of many businesses. A product ban, coupled with weaponised US-dollar sanctions, has the capacity to destroy existing business models. Investors need to start running a risk assessment ruler over the business models of some of our most favoured listed-companies and brands.
Technical outlook for the Shanghai market
The Shanghai Index developed another slow but steady test of resistance near 3,460. The first breakout failed and the index retreated towards the lower support level near 3,360. The current rebound rally started from near 3,398 which is above the support level near 3,360. This provides a third anchor point of tentative trendline defining a new uptrend. It has a very shallow degree of slope, but this is still bullish.
Also bullish is the move above the resistance level near 3,460. Additionally, the value of the index is above the value of the upper edge of the long-term Guppy Multiple Moving Average (GMMA) indicator. The GMMA indicator is used to assess the way the breakout trend may develop in the future following the current index rally.
The long-term GMMA is a guide to the way investors are thinking. The continued compression in this group confirms investors are not strongly bearish. The compression suggests investors are waiting for a strong lead from traders, and for proof the breakout can remain above 3,460 before they enter the market again as strong buyers.
Investors are cautious but not bearish.
The short-term group of GMMA averages provides information about traders. The index has repeated the rebound from a double-bottom test of support near 3,360. During the first rebound, the short-term GMMA compressed and moved upwards to test the lower edge of the long-term GMMA. The current rebound has the potential to move above the upper edge of the long-term GMMA. This shows traders are growing more confident.
This pattern of behaviour is developing a classic GMMA breakout pattern of test: retreat, retest, retreat, breakout. The breakout when the short-term GMMA moves completely above the long-term GMMA is followed by a new retreat and rebound. The retreat is a good opportunity for cautious traders who want to enter into a developing trend.
GMMA analysis helps us to understand the trend. Trading band analysis helps establish trend targets. The long-term trading band dominated in the second half of 2020. The band has three features. These features influence the way the current breakout is developing and are also used to set the upside targets.
The first feature of this trading band is the strong resistance level near 3,450.
The second feature in the trading band is the support level near 3,360.
The third feature is the midpoint of this broad trading band located near 3,360. The index oscillated around this level. The market was bullish when it remained between 3,360 and 3,450. The index was bearish when it was between 3,240 and 3,360.
The width of the broad trading band gives an upside target near 3,630. The short-term breakout target is near 3,540.
Daryl Guppy is an international financial technical analysis expert and special consultant to Axicorp. He has provided weekly Shanghai Index analysis for mainland Chinese media for two decades. Guppy appears regularly on CNBC Asia and is known as “The Chart Man”. He is a national board member of the Australia China Business Council. The writer owns China stock and index ETFs.