Chinese stocks and the Dow Theory
According to Zero Hedge, the Shanghai composite entered a bear market on June 24, since now
it is down -22% from its February highs. Conventional wisdom has it that a bear
market is signaled when stocks go down more than 20%. However, is it necessary
for investors to wait so long (and endure the attendant drawdown) in order to
be “sure” that a bear market sets in? The answer is no, as the Dow Theory gives
as an earlier warning (which is on average -10% from the market highs, and much
less in many instances as we have just seen with the US stock market last week when less than 5% was lost from peak to trough.
As the Dow Theory can be applied to foreign stocks as
was explained in my post “Can Dow Theory be applied to foreign and to
non-stock markets?”, which you can
read here, I wanted to see if there was a way to spot a bear market in Chinese's
stocks well before the mark of -20% were exceeded.
So I plotted the two charts
that you can see below. The upper chart corresponds to the FXI ETF (which
comprises 25 big companies). The lower chart corresponds to the HAO ETF (which
is a small cap ETF). Please mind that I am applying "classical" Dow Theory (i.e. secondary reactions lasting 15 trading days, just two indices ).
The blue rectangles show the
secondary reaction against the primary bullish trend. The red horizontal line
highlights the secondary reaction lows, which, in case of their joint
violation, would entail a primary bear market signal. As you can see the red
horizontal line was violated on March 13, 2013, well before in time and in
losses to the “official” bear market signal.
 |
| On March 13, 2013, the Dow Theory signaled a primary bear market for Chinese stocks |
The closing high of the FIX
was made on 01/02/2013 at 41.85. The violation of the secondary lows, and with
it the primary bear market signal, occurred on 03/13/2013 at 37.34. So
the FIX just lost -10.77% from its January highs.
In other words, had
investors relied on the time-tested (and very logically aprioristically) Dow
Theory rules, investors would have been forewarned with three months in advance
of the beating that is now taking the Chinese stock market, and more importantly, would have protected their equity in a much more efficient way.
Enough for now. The evidence
speaks for itself.
Sincerely,
The Dow Theorist
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