The China Meltdown: Reading the Charts

S&P's Mark Arbeter sees more trouble ahead for Chinese stocks, but thinks the U.S. market will recoverand move higher

For Mark Arbeter, an expert reader of movements in stock and index price charts, sentiment, and other nuts-and-bolts technical indicators, a day of reckoning came on Feb. 27 when China's stock market skidded 9%. "I've been waiting months for this," said Standard & Poor's chief technical strategist as he peered over his computer screens in his downtown New York office.

Back in January, he warned that China's stock market was like a dot-com bubble waiting to burst, given the behavior of the iShares FTSE/Xinhua China 25 Index Fund (FXI), an exchange-traded fund (ETF) that tracks the performance of the largest companies traded in China (see, 1/8/07, "Stocks: The Chinese Correction?").

A few things sent investors worldwide running scared on Feb. 27. When China's Shanghai & Shenzhen 300 Index touched a record high on Feb. 26 after posting enormous gains last year, investors grew wary that the government might adopt new taxes or other measures to dampen the euphoria when China's legislature meets next week (see, 2/27/07, "A Rough Day for China Stocks"). And on Feb. 26, former U.S. Federal Reserve Board Chairman Alan Greenspan said a U.S. recession is possible this year.

U.S. markets also tumbled, with the Dow Jones Industrial average dropping 416 points (3.3%) and the broader S&P 500 index falling nearly 3.5% (see, 2/27/07, "Stocks Slide after China Sell-Off").

Arbeter sees more trouble ahead for China's stocks. The good news is, Arbeter thinks the China sell-off won't hurt the U.S. market for long, and it will recover and shoot up to new highs sometime this year.'s Karyn McCormack spoke with Arbeter on Feb. 27 about his technical take on the market action. Edited excerpts from their conversation follow:

After today's sell-off in China's stock market, how does the chart for the iShares FTSE/Xinhua China 25 Index Fund look now?

The ETF has completely broken down on a technical basis. We're seeing record volume today for the ETF, and it was down 8.3%—that's the worst one-day drop for it.

On a purely technical basis, we have broken below the 50-day exponential moving average [a price average that smoothes the regular average by giving more weight to recent data] and we have also broken key chart support [the price where most investors feel that it will move higher] at 102. We have dropped to a couple of pieces of support that are somewhat significant. The first one is a trend line drawn off the July and September lows. And we have also retraced about 38.2% of the 70% rise that we saw in the ETF from June 13 until Jan. 3, and both of those pieces of support come in around the 97 area. The ETF is at 96.6 right now.

What's next?

I don't think the worst is over for this particular ETF. I think there's a good possibility that the ultimate low will be around the 85 level, which would represent a 27% decline from the all-time closing high on Jan. 3 of 116.4.

In addition, another key Fibonacci retracement level [a price movement in the opposite direction of the previous trend] comes in around the 85 level—that would be a 61.8% retracement of the move from June to January. That would also take us back to a decent size basing formation [flat trading range after a decline] that we traced last year. In big up and down moves, prices typically trace back to the prior base. At 97, it's down 16.7% from the all-time high already—that's fairly significant.

Why do you use the FXI as a proxy for China's market?

I have data for it, and there was a lot of talk about it. It looked like a disaster waiting to happen. The top sectors in the ETF as of Feb. 26 were 18% in telecom, 17% oil and gas, and about 40% financials, including banks and insurance.

What do you see further down the road for China's market?

That's a difficult question. If we get down to the 85 level, the Chinese market could go sideways for an extended period of three to six months. The reason for that is anytime a market falls dramatically, it's very rare that it turns around quickly. What's much more common after a dramatic drop is an index or individual stock will move sideways for a number of months and put in a basing formation, or sideways action.

What does this decline signal for U.S. stocks?

I think what this says about the U.S. market is it has been somewhat clear that there has been a high degree of speculation in global stock markets, and that a fast and quick and dirty correction could take global markets down 5% to 10%. That would include the U.S market.

I don't think this will lead to a bear market for the U.S. This is just a much needed correction in an extremely overbought market. And once it's over, we will probably move to new highs for the U.S market. I'm still positive on U.S. stocks for the longer term, looking out to the end of the year.

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