Too Far, Too Fast? - Chinese Stocks Have Been On A Tear

With economic forecasts showing a big turnaround in growth for the Chinese economy, and articles on state-run media suggesting that stock market valuations remain low, Chinese stocks (as measured by the SSE Composite Index) have recently raced to a two-year high.

And the expectations are that you ain't seen nothing yet.

"China Securities Journal, a newspaper affiliated with Xinhua news agency, said in a front-page commentary that a further run-up is expected because of favourable government policies," reported the South China Morning Post this week. That's akin to a wink and a nod that the government wants to see the market move higher- and local investors have been happy to participate as the SSE Comp. has jumped around 13% already this month.

But some indicators seem to be arguing for at least a pause. At Excalibur Pro, we use a host of valuation and technical tools - one of which is the Markov Process which analyzes trading data to see if an instrument is moving to a different state (regime change). Markov has been showing fairly bullish signals for the SSE Comp. but recently began exhibiting some strong bear signals (see chart below).

In addition, the SSE Comp. price has blown through all of the major moving average indices - and is showing an RSI value of about 90. Generally, when an instrument goes above a 70 RSI value, it is considered overbought. This is way overbought and when you look at the chart below, see what happened last September and this past January when the RSI went above 70.

This has ramifications beyond Chinese stocks - our Relationship Building chart shows the strong correlation relationship between the SSE Comp. and other stock indices in Asia. If China pulls back, it is a good beat that some of the other indices in Asia will follow.