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China Jitters

May 2016

By Bruce Powers, CMT, Chief Market Analyst at, and President at WideVision

Worries about the health of the Chinese economy continue, with analysts fearing China’s huge debt pile could weigh on its growth

China – Hard Landing?
Billionaire investor George Soros says he feels that China is facing a financial crisis similar to 2008 in the US. He made the comments during a roundtable discussion in New York last month stating that growth in China has been fueled by debt and that it is unsustainable. As China moves further into the credit cycle “more and more credit is needed to sustain growth.” A warning was issued from the IMF in April that there were $1.3 trillion in corporate bank loans outstanding by companies that do not earn enough to make their interest payments.
Headline annual GDP in the first quarter was 6.7% according to government reports, however, with seasonal adjustments the implied annual growth rate was 6.3%. China has experienced a rapid rise in debt, growing from 148% of GDP at the end of 2007 to 237% of GDP in the first quarter, according to the Financial Times. Reportedly over 40 companies cancelled new debt sales since March due to market conditions.

Emerging Markets and China equities could weaken
Although concerns over China’s economy has not had much of an impact on global markets since lows in January, that could change at any time. Emerging markets have recovered nicely since then, with the iShares MSCI Emerging Market ETF (EEM) up as much as 28%. However, there are early technical signs that it may be in the process of topping out. At the same time China’s stock market is giving bearish signals. The Shanghai Class A Index has recovered only 17.4% off the January low, versus 24% and better for the two prior advances following the June 2015 highs. A bearish technical signal was given last month with the index falling to at least a six-week low. This points to an eventual test of the January and February lows, with the possibility of dropping further. Keep in mind that the two-month recovery was largely impacted by government intervention. It is now looking like it could fail and the prevailing downtrend to again take hold.

Debt Cycle Coming to an End
In addition to emerging markets and China keep an eye on the high yield or junk bond market. The sector led the markets lower into January/February and may be getting ready to test those bottoms. Bank of America analyst Michael Contopoulos sent a warning last month that we may be heading for the worst debt default cycle in history. High yield should give an early warning sign as the sector is generally more sensitive to changes in investor sentiment than higher rated debt. The SPDR Barclays High Yield Bond ETF (JNK) has recovered as much as 12.31% from its February low and is now stuck up against resistance of its long-term trend indicator, the 200-day exponential moving average. JNK has been below this moving average since September 2014, making it an important barrier to higher prices and increasing the odds for a turn down. However, if it continues higher, a continuation of the almost two-year downtrend will be postponed.

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