January 5, 2016
On Monday, U.S. investors awoke to stock futures in the red, as the Shanghai Composite Index had closed lock-limit down. For the first time, its new circuit breakers got a test drive. The two questions everyone is asking: (1) How much farther can Chinese markets sink, and (2) Will they drag U.S. markets with them?
U.S. stocks pared losses Monday into the close, with the Dow down -1.58% and the Nasdaq Composite suffering a larger -2.08% loss. The Shanghai re-opens tonight at 8:15 pm ET—a time when investors across the world will get a peek at what tomorrow’s market action might bring.
U.S. investors can gain exposure to the Chinese market through the FXI exchange traded fund (ETF). When FXI is superimposed on a chart of the Shanghai Composite, a telling picture emerges: the ETF leads the index and is currently showing more weakness.
The peak in FXI occurred in mid-April 2015, nearly two months before the peak in the Shanghai Composite, which decisively broke a longstanding trendline stretching back to late August 2015. Meanwhile, FXI plummeted to horizontal support. This level needs to hold to avoid triggering massive stop losses, which would send the market down further.
A historical analog paints an even bleaker picture. During the U.S. tech bubble, the Nasdaq Composite gained nearly 280% from October 1998 to its peak in March 2000. The Nasdaq subsequently lost over two thirds of its value over the next year. A similar move in the Shanghai Composite would bring it down to about 2200, or another one third down from last year’s low.
Whether Monday’s price action was the final one-off or a bellwether of 2016 remains to be seen, but a quick snapback in the Shanghai would allay investors’ fears around the world that further carnage is at least delayed.