2010-07-26 10:59

Three important events occurred in global markets last week. They suggest a significant economic change is developing. The events are:

The failure of the breakout necessary to invalidate the head and shoulder pattern in the US Dow index;

The successful breakout above resistance at 2500 in the Shanghai index;

The invalidation of the developing head and shoulder pattern in key Asian regional markets.

The rally in the Dow has ended and this confirms the bearish head and shoulder pattern. In 1929/30 the head and shoulder pattern preceded the double dip going into 1930. The Dow is repeating this behavior. If the head and shoulder pattern is fully validated by a weekly close below the value of the neckline at 9700 then the minimum downside target is 8400. This pattern suggests growing economic weakness.

The China market is developing a reversal bottom. The downside targets set by the equilateral triangle pattern have been exceeded. A new fan trend rebound pattern has developed. There is strong support near 2480 and this is the base of the fan reversal pattern. The market dip towards 2300 was a last shakeout of the weak hands. The fan reversal pattern suggests the market is developing a strong and sustainable trend change. It still has several weeks to go before it is fully developed. This is a long-term pattern. It is also a regular pattern in the Shanghai index, preceding the 2004-2005 market reversal.

There is also the potential for the Shanghai Index to develop an inverted head and shoulder reversal pattern. This pattern would be confirmed with a retreat and retest of support near 2480 following the current rally. Both of these chart patterns suggest growing economic strength and recovery.

Markets in Asia and India traditionally depend on the behavior of the US market. This relationship is changing. These markets do not have strong reversal patterns, but they also do not have strong rebound trend patterns. These markets have been trading in sideways patterns for six to eight months.

The Korean Kospi is the leading index in the Asia region outside China. It developed a weak head and shoulder pattern. The Indian Sensex also developed a weak head and shoulder pattern. These patterns were weak because the height of the left shoulder was not far below the peak of the head of the pattern.

In the last week the rally in all these markets has continued and indexes have risen to make new 12-month highs. This is a bullish breakout from a prolonged sideways trading band.

The width of the trading band is measured and used to set the upside targets. This breakout from the trading bands shows an increase in upwards momentum. This strength develops because these markets are more strongly influenced by the growth shown in the China market. This is a key change in global economic relationships.

Together these three elements suggest important shifts in the global economy. American growth depends upon giving consumers yet another credit card. Economic growth cannot be driven by domestic demand because there are limited opportunities created by a satiated consumer. A matured economy has limited growth options.

China growth depends on giving consumers more money to spend and encouraging them to draw down on their savings. The recent wage increases provide a direct stimulation of domestic demand. The benefits of the increase in domestic demand far outweigh the drawbacks of a few foreign companies leaving China to produce cheap goods in Laos or Cambodia.

The regional economies such as Korea, Singapore, Malaysia, and also India, stand to benefit as exports into China grow to meet the increase in demand. This suggests that a substantial decline, or double dip, in the US and European economies will not drag down Asia as it did in 2008. There will be an impact, but it will be reduced by the substitution of demand from China.

The author is a well-known international financial technical analysis expert