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CHART: Here's one simple explanation for the rout in Chinese stocks

Photo by China Photos/Getty Images

China closed the stock market in Shanghai early yesterday when the index fell by 7% and triggered a automatic trading limit.

That sent a wave of fear around global stocks overnight and hit China-linked currencies like the Aussie and Kiwi dollars. Commodities also were whacked with copper falling 2.58% and Nymex crude reversing yesterday’s gains to be more than 1% lower.

Part of that weakness in Chinese stocks was the release of weak manufacturing PMI data.

Another part of it, at least to Western traders trying to rationalise what happened, was the continued push by China’s central bank, the PBOC, to weaken its currency, the yuan.

Yesterday’s official fix rate of 6.5032 to the US dollar spooked forex traders and the official yuan rate was then hammered to close the day at 6.5338. That’s its worst close since April 2011 (remember a higher USDCNY rate means the yuan is weakening). The unofficial rate, the one most non-Chinese traders have access to, also weakened sharply to be sold off to almost 6.63 this morning.

So this morning the global search for the catalyst of yesterday’s carnage in Shanghai stocks is in full swing.

There is talk that it wasn’t just the weak data or the yuan fix but rather that the selling yesterday might have been due to fear of a wave of unlocked shares hitting the market as the government’s 6-month ban nears expiry.

All of this might be true and no doubt contributed to some pressure on stocks.

But the acceleration in selling of stocks by traders in Shanghai yesterday also happened for another very good reason. The move of prices down and through 3,500 on the Shanghai Composite index broke the uptrend in stocks since government intervention brought August lows.

If you are a technical trader, as many in China are, then that is a red flag, a signal to sell.

Shanghai Composite Daily – Reuters Eikon

The intraday price action supports this thesis with the initial break seeing a heavy fall once this level broke, then again after the market tried to consolidate. But when it couldn’t rally the sellers came again and stocks hit their down limit.

Many will be wondering what’s next.

The automatic suspension of trade yesterday is an exchange mechanism to try to avert full-blown market panics.

So there is every chance that when markets open today, this circuit breaker might have worked and cooler heads will prevail. But given the selling around global markets and the real possibly there are still large volumes of unfilled sell orders, the books yet to be executed, it could be another bad day.

Globally, markets will be watching closely.

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