Hopes that we may see a Chinese-led recovery have been dashed for the time being. After a strong two-day rally, Chinese stocks fell back sharply overnight. As a result, the losses for European indices sharply increased at the open this morning while US index futures also fell across the board.
Chinese equities, which had been hit the hardest this year, rebounded at the end of last week and start of this in part because of the Chinese government promising to provide more stimulus to stabilize its economy and offset the impact of US tariffs hurting its exports. In addition, there was some speculation that the US and China were going to put aside their trade spat and come to an agreement of some sort at the G20 meeting in Argentina next month, where US President Donald Trump and Chinese President Xi Jinping were likely to meet. However, those hopes were dashed when White House economic adviser Larry Kudlow accused China of doing “nothing” to defuse the trade tensions.
Equity prices have also been hit by valuation concerns, which is especially the case on Wall Street. Compared to the rest of the world, US shares had been getting extra support due to a stronger US economy and more recently as a result of Trump's tax cuts and companies buying back their own shares. But the impact of the tax cuts are beginning to fade and with employment at full throttle and interest rates on the rise, the economic expansion could be slowing soon at the world’s largest economy. So, going forward there is a possibility that we could see short-lived bounces in a downward trajectory for the major US indices. Growth stocks such as technology shares are really crowded and we may see more pain than gain to come in this particular sector.
In addition, stocks are undermined by growing concerns over rising bond yields with a few major central banks being on a hike of cycle with a few more set to join them next year. As the so-called “risk-free” yields rise, this reduces the appeal of other higher-yielding assets such as stocks. Although US 10-year bond yields have fallen back slightly over the past few days, the trend has been bullish and we wouldn’t bet against the trend.
So, if the weakness persists then US stocks might be the next big domino to fall, as so far they have outperformed the rest of the world. Thus they might have some catching up do on the downside. However, in the event the bulls re-merge, then the German DAX — which had been hit the hardest among the European indices (in part because of concerns over Italy and fears over demand for Germany’s luxury cars from China) — could be the one to watch for potential outperformance.
Stocks can easily bounce back of course if sentiment were to turn positive again. This could be triggered, say, by positive developments in the China-US trade spat or stronger-than-expected company earnings results (with this week being the busiest in the US reporting season), among other things. But for the time being, there is no end in sight in the downward trend for the major global indices.
Nasdaq 100 below the 200-day average
Among the US indices, the Nasdaq 100 could be the one to watch for further weakness given the larger technology sector weighting. The index has already met its double top objective, but more weakness could be on the way if it starts to move more decisively below the 200-day average. The next immediate bearish objective would be this month’s low at just below 6890. Below this level is the 61.8% Fibonacci retracement level at 6750, followed by and old untested broken resistance at 6670. Last year’s high comes in at 6545. Meanwhile on the upside, yesterday’s low comes in around 7050 and this would be the first level of potential resistance to watch now. But if we go above yesterday’s high then there is a possibility for a deeper retracement towards 7390 again, which is now the key resistance level that the bears should defend if they are to remain in control.
Source: TradingView and FOREX.com. Please note, this product is not available to US clients