China's Shanghai Exchange (SSEC) has decisively broken below a trading range and is dropping fast, down 5% Monday, 20% since early May and 25% so far for 2010. Just ten days ago, as China announced more tightening, Marc Faber warned of a China crash. Dr. McHugh put out a crash! call this weekend. After the big drop off 2007, it was first to rebound, starting in Nov08, and the first to peak, in Aug09. It has been in a big sideways move ever since, but has now dropped below the lower trendline (chart courtesy ContrarianAdvisor):

It is down 25% in nine months, and well below the 200 DMA, both signals for a big bear market. Earlier this month the momentum oscillator (ROC) crossed to negative, another bear confirmation. When the 50 DMA fell below the 200 DMA in late March, it was a Death Cross signal:

Now, a case can be made that this is a short term drop, not a crash, but it is getting more difficult after the fast drop of the past two weeks. Given the volatility of the SSEC, these signals may go away quickly; also, while it looks like the SSEC is foreshadowing US markets, the reality is that it is much smaller and some pundits say it has little impact on the US. Instead, it is more like the NASDAQ, driven by the retail investor, as compared with the other Chinese exchange, the ADR, driven by institutions. (For a really good dissection of the SSEC, go here.) Hence the views of Jim Trippon, who expects a bounce, and the blog trendlines, which follows China and India closely, that expects a bounce as well. Trendlines reasons that while the SSEC is in a bear market, after the current downturn, it will go back above the Aug09 levels to complete a C wave of a big ABC off the Nov08 low. So far it has only retraced 2% of the big drop off 2007, and a 50-62% is more common, as we saw with the Hope Rally:

In some respects, however, the SSEC both presages and reacts to other changes globally. It may not lead the US, but it acts as the most sensitive canary in the global coal. As I will lay out more in a post on commodities, a fall in the SSEC preceded the big bubble peak in commodities in 2008, and it may be signaling the peak of the bubble echo in commodities. The logic is straightforward: China has become a huge buyer of commodities, and in the past year has been stockpiling. A fall in the SSEC is the leading indicator of a pullback in China's economy.

Also, Euro weakness may be hitting China. Europe is a large trading partner with China, and the Euro drop may accelerate an SSEC drop, as it means less imports from China. The SSEC may not yet be responding to that, but they will.

Most likely the SSEC is falling because Chinese manufacturing growth is slowing. The tightening is having an effect. This was signaled by the turndown of the Chinese PMI in Q1:

It is interesting to read economist opinions on China's red hot 11.9% GDP growth in Q1: largely sanguine about Chinese prospects even though the Q1 jump is largely an artifact of a weak Q1 a year earlier. There have been concerns over suspicious Chinese stats. They measure GDP differently - essentially when budgeted, not as actually produced. The hot Q1 really means spending is out of control, hence the tightening, which includes some fairly dramatic nullifications of local government loan guarantees - an indication of out of control debt-fueld bubble.

Another indication was the surprising Q1 trade deficit. Those sanguine economists opined it meant China was rebalancing, meaning increasing consumer spending (imports from trading partners). On the contrary, it was due to investment-growth, not consumption. Imports surged due to stockpiling of commodities, and exports weakened due to weakness in the US and Europe:

Other than a passion for imported cars, which is driven by their version of Cash4Clunkers, China is not on a consumption spree:





Instead, China seems to be careening down the Stimulus Road, out of control, and now trying to grab the steering wheel. The WSJ has wondered what China will do to push back an incipient inflation, and believes they will have to allow the RMB to appreciate. Mish then asks this question in regards to a rise in the RMB, given tightening:

What would happen if China stopped its stimulus cold turkey, pricked its property bubbles, and allowed the RMB to float freely, and in response the Chinese stock market collapsed, social unrest picked up, and hot money poured out of China?

Well, the stock markets in China are crashing. China 2010 may be Japan 1989. The huge Chinese stimulus has caused surges that look a lot like Japan after the Plaza Accord in 1986, or the US in 1927 after the Brits went back on gold at the wrong level.