Although optimism was riding high after the second quarter GDP print, the latest Chinese trade figures continue to indicate the uninspiring impact of highly accommodative policy measures. Besides the external trade headwinds which are weighing heavily on economic activity, the enduring efforts to hit the central government’s ambitious growth targets have only raised the risks for the outlook. As evidenced by the bubble forming in residential real estate, the risks of greater action may in some ways exacerbate the underlying problems instead of providing a solution. The one major policy tool that the People’s Bank of China continues to deploy in the fight against a prolonged slowdown is adjusting exchange rates, a development that has created other ancillary problems that must eventually be dealt with.

The Export Economy Re-Collapses

According to data released overnight by the general administration of customs, Chinese exports fell by -10.00% year over year, marking 6-consecutive months of contraction and underperforming the consensus estimate of a -3.20% decline. Aside from contributing to the smallest surplus in 6-months, export activity is signaling a prolonged slowdown in trade with many advanced and emerging economies. The two bright spots were trade with India and Russia which climbed 1.30% and 7.10% respectively. Nevertheless, the collapse in trade with other prominent partners underscores the significant challenges facing policymakers as they work to meet the 6.50% to 7.00% GDP growth target set by the Central Government. So far, fiscal and monetary stimulus have been unable to reverse the slide in trade and inflation, simply contributing to growing asset bubbles, namely in real estate.

Due to the perceived unwillingness of policymakers to accommodate rates further, the most popular tool used to combat decelerating growth and tepid inflation has been a unilateral devaluation. The Yuan, which recently hit a 6-year low against the US dollar, has been the main instrument behind the resurgence in economic activity. Unfortunately, it has not worked perfectly as evidenced by foreign exchange reserves and capital outflows. In an effort to defend the devaluation, the Central Bank has been forced to sell dollars, a costly endeavor that has seen reserves plummet from just shy of $4.00 trillion in June of 2014 to $3.167 billion as of September. However, the side-effect of the devaluation is the continued pace of capital outflows as citizens race to move their savings into other currencies to avoid further losses that may stem from the Yuan depreciation.

With limited tools left to explore, markets are already waking to the predicament facing China as officials work to prevent a crippling slowdown that could paralyze the economy and create high levels of social unrest. Leading indicators such as trade and manufacturing continue to suggest that conditions remain shaky on the mainland and continue to contribute to a weakening outlook for growth. Other important leading indicators of economic activity, including stock benchmarks, are largely confirming the level of uncertainty plaguing the outlook. Although the Yuan devaluation has certainly made stocks more attractive from a relative value perspective, the Hong Kong Hang Seng is not buying the growth tale. Instead, the steep equity losses that transpired after the release of trade data may be symptomatic of shifting sentiment, a development that will do further damage to valuations over the days and months to come.

Indices as a Proxy for Trade

Often seen as a strong proxy for how the Chinese economy is behaving, the Hang Seng index has come under notable pressure since the release of the trade data earlier in the session. After the near vertical climb in the index during April of 2015, the index retreated significantly, bottoming out early in 2016 before reversing higher from the longer-term downward trend. Since then the rebound has been substantial, with the Hang Seng climbing over 33.00% from the February lows. However, the rally looks to have found a ceiling with the emerging triple top and potential breakout to the downside. The first major sign of trouble is the index falling below the 50-day moving average which was formerly acting as support. Despite a bullish moving average crossover that occurred in early August, a second candlestick close below the 50-day moving average would be strong confirmation of a deeper retreat.

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On a more medium-term basis, several bearish developments have transpired that add to the more bearish outlook for the Hang Seng. For one, the price action over the last month and a half has been decidedly range bound, trending between resistance 24,090 and support at 23,205. Besides three points on the upside indicating a triple top in the price action which suggest a significant level of resistance, the trade data reported by China was enough to force a breakout from the range to the downside. Based on a range of 885 points, a 60.00% to 75.00% breakout move implies downside potential of between 531 and 664 points, implying a potential move towards 22,674 to 22,541 over the near-term. However, should the Hang Seng manage to rebound back into the range, it could indicate a fake breakout move, necessitating more patience.

Looking Ahead

The major upcoming event of importance for Chinese officials is consumer price inflation data set for release on Friday. The prevailing hope amongst policymakers is for a more positive inflationary reading which would give credence to the high levels of ongoing accommodation. However, should price inflation fail to bounce, it could suggest further reductions in the benchmark interest rate, lower bank reserve ratio requirements, and a new wave of fiscal stimulus. However, considering the diminishing marginal returns of adding more accommodation over the last year, officials are more likely to focus on devaluing the Yuan. Should other fundamentals including manufacturing continue to slip over the medium-term, equities may continue to more closely reflect the economic turmoil brewing in China.