Wednesday, July 1, 2015



What was predicted for China has started to happen with the dramatic failure of its parabolic uptrend, leading to a plunge.

The whole world piled into what had been the hottest stock market in the universe. Chinese stocks had been endlessly hyped in the US and elsewhere. For the smart money, it was a game of chicken; ride it up and get out just before the crash.

Chinese stock markets had more than doubled in 12 months, propelled also by margin debt, cheap credit all around, and the irresistible desire to get rich quick. Everyone in China, from street vendors to housewives, suddenly opened margin accounts in Hong Kong and mainland China, and borrowed money to buy stocks. Outstanding margin debt ballooned to $348 billion, even while insiders were reportedly dumping stocks. A well-oiled wealth-transfer machine.

It was one heck of a party. By early June, it had created $6.5 trillion in "value" over a period of 12 months. Then someone accidentally turned off the juice.

Over the last ten trading days, the Shanghai Composite Index has plunged 19%, including 7.4% on Friday – the steepest two-week plunge since December 1996. The Shenzhen Composite has given up 20%, and the startup-focused ChiNext Index has plummeted 27% over the last three weeks, including 8.9% on Friday. According to Bloomberg, by Thursday, margin debt has dropped four days in a row. Markets were running out of propellant.

If stocks continued to plunge, it would trigger more margin calls, which would trigger more forced selling, which would depress prices further and thus trigger more margin calls….this could lead "to a stampeed" There is a risk of collapse in China's stock market which has substantial margin trading and leveraged funds. Local governments too are drowning in debt. They need to issue about 2.8 trillion yuan ($451 billion) of debt this year to stay afloat and keep the economic mirage alive. They too need liquidity to do this, but that liquidity has been evaporating. In China's real economy, meanwhile, a very hard landing is in process.

While low grade Chinese speculators who are leveraged to the hilt and up to their eyeballs in margin debt may have been unnerved by what has just transpired and are probably starting to break out in a sweat, it is unlikely that they appreciate the full gravity of the situation – many of them think that this is just a correction. So they are likely to buy this dip, some of them appreciative of the opportunity to get more stock at better prices. They have no idea what is really going on.

The market has just dropped back from the peak of the Head of a Head-and-Shoulders top shown on the first chart below and if this interpretation is correct it should now rally from the vicinity of the low of the Left Shoulder trough of the pattern, that occurred early in May, where there is support.

The expected Right Shoulder, projected to form as shown on the chart in red, will be the final trap. Once it descends from the peak of the expected Right Shoulder, after a little hesitation at support at the "neckline" of the pattern, where we might see a minor bounce, it should breach this support and then crash – not drop – crash – because the low grade highly leveraged speculators who currently populate this market will be forced to flee in panic.

Chinese market action has some implications for other Western markets, since a crash in the Chinese market is likely to have a knock-on effect on bloated markets elsewhere. If the Head-and-Shoulders top in the Chinese market completes in a symmetrical manner, we will have a few weeks to a month until we have neckline failure and a crash, and, perhaps, a month or two to prepare for Western markets to follow suit.

Recent action is shown in more detail on the 6-month chart below with expected pattern development shown in red…

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