China Update – 12/25/2015

There has been a noteworthy rally in the Shanghai Composite Index since the August low, but I am not ready to call a bull market yet. In July, I wrote that historically, Chinese bear markets have either entailed a ~50% drop with subdivision, or a ~70% drop without subdivision. As of the August low, the Shanghai index was down 45% with no obvious subdivision on the monthly chart. Thus, I think there is a high risk that the current rally is only a bear market rally. Furthermore, in previous Chinese bear markets, there were bear market rallies of duration similar to what we are seeing now. On the chart below, green arrows are pointing to those rallies.

china rally dec 2015

As for what a continued bear market in China would mean for the U.S. markets, the periods of 2003-2005 and 2009-2013 show that it is possible for the U.S. to trend higher even if China is trending down. However, despite trending higher, the U.S. stock market had some lengthy sideways movement during 2004-05 and 2010-2012 was a volatile period. So, if China is still in a bear market, next year could be bumpy for the U.S. despite an overall uptrend.

Update – 12/05/2015

I’m finally back after having been swamped with duties outside the blogosphere here lately.

I see two ways to interpret the recent action in the U.S. stock market from an Elliott Wave standpoint that fit with an intermediate-term bullish view. I’ve illustrated the first possibility on the Dow:

dow dec 2015 scenario 1

This view assumes that this year’s correction officially ended at the August low, and that since then we have been undergoing a five-wave pattern higher. Within that pattern, you could say that the 4th wave ended at the Nov. 16 low, or you could say that we’re still churning it out now in some sort of sideways pattern. Either way, the 5th wave up would likely take us to new highs. It’s hard to say how high it would go, but a Wave 1 = Wave 5 relationship would put us in the 18800-18900 range.

The other scenario, which is even more bullish for the short term, depicts the correction as “officially” ending in September instead of August. I have illustrated this on the S&P 500.

spx scneario 2 dec 2015

Under this view, the Primary 4 correction labeled in blue was an expanded flat (ABC) which followed the form of two waves down, two waves up, then five waves down. In this scenario, we had a 5th wave truncation in which the 5th wave failed to make a new low. From the late-September low, we had a Wave 1 into early-November, then a Wave 2 that either ended on Nov. 16 or is still underway now. Either way, the 3rd wave should be at least as long as the 1st wave, which implies a rally to at least 2250. After that rally, there would likely be a shallow drip to form the 4th wave, then a 5th wave up to new highs. On the Dow, the comparable scenario would give us a 3rd wave target of 19200-19300.

Comparing these two scenarios, I am somewhat in favor of the second one. That is mostly because the Aug-Sept rally was looked very corrective in nature. The 5th wave failure to make a new low could be attributed to the ultra-strong 3rd wave down in July-Aug. The other evidence in favor of the second scenario is that, if you put the wave count of the first scenario on the S&P, the 4th wave of the new uptrend would overlap the 1st wave, which is an Elliott Wave no-no.

The evidence in favor of the first scenario is that the November drop was rather mild, and wave 2’s tend to cut deeper into the prior rally. Even if the 2nd wave is still underway, the strong moves off the lows of Nov. 16 and Dec. 3 lead me to think that we are not about to see a sharp plunge below the Nov. 16 low.

I’d say the odds are 50/40 in favor of the second scenario (the more bullish one for the short term). The remaining 10% chance is that something altogether different is going on (always worth allowing for that, you know).