After a sordid year of continuous losses, signs of hope are starting to appear in the Chinese tech sector. Is now a good time to buy?
So far, 2021 has not been kind to investors in Chinese tech stocks. Since February, the market has been free falling in a vicious bear market which wiped 58% off the value of the Kraneshares China Internet ETF from its highs. See figure 1. This is the largest drawdown the fund has seen since its inception in 2013.
Despite the bearish sentiment, there are signs that buyers are ready to start entering the market again. Technology conglomerate, Tencent, is one of the largest constituent stocks in the sector. Its price chart is shown in figure 2.
As far as trend analysis is concerned, this stock is at a significant juncture. Since February highs, Tencent has been in a confirmed downtrend, as characterised by sequentially lower lows and lower highs. That was true, at least, until the recent higher high formed on September 7th, and the subsequent higher low on September 21st. This is known as a non-failure swing under Dow Theory. Note that this is still technically a downtrend. The recent higher high and higher low are indicating that we should be prepared for the beginning of a new uptrend, but no confirmation has occurred yet. That would require a break above prior resistance at $67.67, at which point a new uptrend would officially begin.
The chart of Alibaba in figure 3 shows a very similar picture. The sequence of lower lows and lower highs has been interrupted by a break above prior resistance, meaning the next peak which forms will necessarily be a higher high. Again, this is cause for alertness but it is not yet confirmation of a new uptrend. That would require the establishment of the next high, followed by a higher low, followed by a break above the prior high. The trends in both Tencent and Alibaba are exhibiting a significant change in behaviour which serves as a valuable early warning sign that a major reversal and change of trend may ensue across the whole sector. That being said, we still await the vital confirmation of a change of trend in both stocks, and the broader sector. How likely is it that confirmation eventually materialises? A major clue lies in the price action of some of the sector’s smaller capitalisation stocks.
Figure 4 shows shares of e-commerce giant JD inc, which has a market capitalisation around one fifth that of Tencent. For this stock, a new uptrend has already been confirmed via a double bottom reversal. Confirmation came back on August 24th with a break above the prior high after a double bottom, and the stock has since been forming higher highs and higher lows.
Now see figure 5, which shows shares in Baidu inc. Baidu is also technically in a new uptrend, as confirmed by the break above prior resistance on October 18th. With all correlated markets, some charts will always “lead” others by confirming new trends before the rest of the lagging charts. Find the leading charts, and you have a very good indicator of where the rest of the market is likely to follow. In the case of China’s tech sector, Baidu and JD appear to be leading.
Statistically speaking, the correlation between Chinese tech stocks is undeniable and significant. For instance, since the February peaks, Baidu and Tencent shares have had a correlation coefficient averaging 0.67 (where 1 implies perfectly correlated and 0 implies no correlation). JD and Alibaba have averaged a 0.64 correlation coefficient.
If these early confirmed trends are to persist, and the present interconnectedness of the sector is to remain intact, the Chinese tech sector may be primed for a new and very substantial bull market indeed.