In part 1 of our commentary, we discussed the current Fundamental Gravity of our “Slowing Dragon” macro theme. If you missed part 1, I encourage you to read that first, before jumping into part 2 here, writes Landon Whaley Friday. He's presenting at MoneyShow Dallas.
We covered a great deal of critical fundamental developments, which are bearishly impacting Chinese equities and the US-listed ETF, the iShares MSCI China Large Cap ETF (FXI).
Quantitative Gravity says what?
As a quick reminder, the Quantitative Gravity component of our Gravitational Framework is not technical analysis, which is ineffective and misleading. Rather, we use quantitative measures based on the reality that financial markets are a nonlinear, chaotic system.
We’ve identified four primary quantitative dimensions of financial markets that affect price movement: energy (trend), force (momentum), rate of force (buying pressure), and a market’s irregularity (level of imminent drawdown risk).
Social is our measure of a market’s current energy (or trend). FXI’s Social reading indicates it is fully in a hangover. Given the Fundamental Gravity we just discussed, FXI’s bear market will be intact for the foreseeable future.
Momo is our measure of the amount of force behind the market’s current state. FXI’s Momo has been predominantly bearish since February 9. Momo managed a benignly bullish reading from May 11 to June 14, but it was all bear before and it’s been all bear ever since.
Barometric is our measure of buying and selling pressure or the rate of force behind the current Momo. FXI’s Barometric indicates that sellers have been firmly in control of this market since February 16.
Topo, which measures the probability of a drawdown, is indicating a high level of drawdown risk for FXI over the next 10 trading days. This quantitative factor has been extremely elevated since June 25.
Alpine and Abyss Lines
Our proprietary Alpine and Abyss lines are not “support” and “resistance.” Rather, they are the areas above and below the most recent closing price where price is likely to experience an acceleration in its current trajectory, or a possible reversal of its current course. We calculate these critical prices utilizing fractal geometry and Chaos Theory as the foundation to analyze the underlying market structure, which is not visible on a price chart.
When a particular market’s price interacts with the Alpine or Abyss areas, regardless of whether the price is rejected by the Alpine or Abyss area or is able to breakout above (or breakdown below) it, the outcome gives you critical insight into the most likely direction of that market.
The most critical Alpine area for FXI above Friday’s closing price is between $43.05 and $43.83. This means that it’s highly likely that any upside price momentum will stall at this area. However, if FXI closes decisively above that area, price is likely to accelerate higher to $44.65.
The most critical Abyss area for FXI below Friday’s closing price is between $40.21 and $39.70. This means that it’s highly likely that any downside price momentum will stall at this area. However, if FXI closes decisively below that area, price is likely to accelerate lower to $39.17.
The Quantitative Gravity bottom line is that all factors for FXI remain extremely bearish. When shorting a bear market as entrenched as Chinese equities are currently, it’s critical that you risk manage the inevitable dead cat bounces.
Behavioral Gravity says what?
Behavioral Gravity allows us to evaluate investors’ perception of this market and how that perception changes and shifts over time.
The Behavioral Gravity Index (BGI) for FXI has been extremely bullish all year now, which completely baffles us. Despite the uber bearish Fundamental Gravity, investors have plowed an additional $1.1B into FXI this year alone. These inflows represent approximately 25% of FXI’s entire $4.4B asset base! What’s even more nuts is that since FXI entered crash mode (declining 20% from its January 26 peak) on June 29, investors have added $672MM. This means investors added the majority of their new funds to FXI after this market crashed!
The behavioral bottom line is that investors are displaying classic humanness, attempting to catch falling knives by adding more money to FXI after its intra-2018 crash. When the three gravities align this way, you wait for a short-able bounce and you go huntin’ for wabbit!
The Trade Idea
As long as FXI trades below $43.83, new short trade ideas can be initiated opportunistically on rallies. Depending on your entry and how much room you want to give this trade idea to move, use a risk price between $43.05 and $43.83. That said, your risk price line in the sand is $43.83. If FXI closes above that price, exit any open trades. If the trade moves in your favor and FXI trades down to the $40.21 area, consider closing some, or all, of your position.
In addition to providing detailed analysis and trade ideas like this commentary on a weekly basis, we also provide real-time email alerts whenever we add, or close, a position in our Asset Allocation model inside our Gravitational Edge report.
We are currently out of FXI in our Asset Allocation Model and will send out an alert if we get the right entry price that skews the reward-to-risk characteristics of the short trade in our favor.
Please click here and sign up if you’d like to receive an email alert when we initiate our position in this market and to participate in a an eight-week free trial of our research offering, which consists of three weekly reports: Gravitational Edge, The 358, and The Weekender.
