In today’s Exponential Investor

  • Chinese tech diverges
  • More support for the gold price?
  • A better way to trade

One of the stories of recent months has been the Chinese crackdown on tech companies, and the education sector.

Foreigners are no longer allowed to teach English, education tech companies are no longer allowed to take profits – meanwhile, the crackdown on the Ant Group initial public offering (IPO) and the disappearance of Jack Ma, as well as the botched listing of Didi, have all contributed to huge sell-offs in Chinese stocks.

You can see the effect this has had below, when you compare the (blue) Chinese stock market to the S&P 500 in the United States. Until this year, both had seen almost identical market rallies after the covid-crash of March 2020:

Source: Koyfin 

Now we are seeing a “divergence”. Two things, which for a time appeared to be correlated in some way, are now suddenly taking very different paths.

Often this is used to suggest that the gap must close. If you are of a bearish tendency, for example, you might use the above chart to say that the US stock market is ripe for “a little tumble off the cliff”.

This is a specific case of political risk impacting the markets though, and you can see this even more clearly when you single out the tech indices for each country – the KWEB ETF for China and QQQ (the Nasdaq composite) for the United States:

Source: Koyfin 

Will Chinese tech lead the rest of the market lower? Will China lead the rest of the world lower?

Some stock markets are well over 100% up from their early pandemic lows of April last year. The S&P 500 has gone nearly 200 days without a 5% decline…

Can it go on?

The divergence is, however, a good example of what politics can still do to stocks. How much it can still matter, and how national risks remain a key consideration for investors.  

The jurisdiction of your investments does matter, and it’s not hard to imagine that a number of investors will be shy for a while, when it comes to investing in China.

The same is true for gold miners. Gold mines aren’t all based in the safest and most developed nations, and emerging market risk to many projects is an important factor to consider. 

Speaking of gold…

There are currently other divergences like the one that has appeared between the Chinese and US tech indices.

I mentioned on Tuesday that Charlie Morris’ fair value model for gold had opened up a sizeable gap.

The same is true of gold and inflation-linked bonds. The latter have continued to surge, while gold has faltered in recent months:

Source: Koyfin 

One would expect these two to trade in similar ways, given that inflation is a key component of what drives them both, as well as interest rates.

But one of the problems with this kind of analysis is that it’s hard, if not impossible, to know in which direction the “jaws” will close.

Will Treasury Inflation-Protected Securities (TIPS – index-linked bonds in the United States) fall in price, or will gold catch up? It’s hard to say. It still depends on your views on the asset classes themselves… and such charts and analysis are often used to promote one asset class relative to another.

So be careful next time you see a divergence chart like this, with someone arguing that a tumble or a rally awaits.

Such things can go either way.

Beware the third Friday of the month

A curious phenomenon has emerged.

The excessive use of options by retail traders, urged on by Robinhood which makes much better margins when its new, young investor base trades options (rather than anything else), seems to be causing market stumbles around the same time each month.

According to Bloomberg, “It happened in July, when the biggest downdraft was its 2.7% slide over the three sessions through the 19th. In June, the share benchmark lurched 1.3% on the 18th, its largest fall of the month. May saw a three-day decline ending the 19th knock 1.4% off the index, though a plunge the week before was a bit bigger. And a 1.2% drop over two days ending April 20 was that month’s worst.”

And this week?

Sudden drops on the open, rapid comebacks, and whipsawing volatility after a very mellow couple of weeks.

So perhaps the curse of the date is striking again?

It’s all to do with options.

You see options on the market trade with monthly contracts, which mean they expire.

If more options are being traded than normal, especially by inexperienced traders, then over the course of the month, imbalances can build up.

August’s option expiry date is Friday 20 August… tomorrow.

So, perhaps, as the option market unwinds and rolls over once more, more turbulence could be heading our way.

Along with the divergences between two assets though, such small details aren’t much to base a portfolio around.

They might be little signals, trading opportunities or just interesting quirks.

I find trading fascinating, and technical analysis too – but I’m not a true expert.

My suspicion is that it would be a valuable tool in its own right, or as part of a long-term investor’s toolbox. So I’m always keen to pick up new ideas and learn more.

If you’re like me in that regard, either as a pure trader or an investor interested in adding to their skillset, then I must mention our partner company, Trendsignal.

They offer both software and the training to use it to teach people how to become better traders. It doesn’t matter if you trade FX, crypto, or major indices, you can use their strategy to focus on capturing smaller, regular gains rather than going for broke.

If this sounds like something you’d be interested in, you can find out more about Trendsignal here.

All the best,

Kit Winder
Co-editor, Exponential Investor