Perception vs reality in markets
THE gap between perception and reality is called opportunity. It has been many years since the gap has been quite as large as it is now in US markets. How we react to this gap determines both trading and long-term investment outcomes.
Many economic commentators in the US appear to believe that the US is winning the President Trump-initiated trade war with not just China, but also the world. Trump tells the media that he has concluded more than 200 deals as a result of his tariff mayhem.
All markets rebounded rapidly after the initial collapse immediately following his 'Liberation Day' announcement on Apr 2. In US markets, the rebound followed Trump's pullback on tariffs. Whether that is evidence of winning remains an open question. However, the narrative favoured by Trump and his trade advisors like Peter Navarro is that America is winning the tariff war, and that despite a small pullback in GDP, the future for the economy is very good.
But there is a small and growing group of analysts and fund managers who have a more bearish outlook. They claim to be realists. They point to the fall in GDP numbers and a US Purchasing Managers Index figure below the critical 50 level.
They point to China's refusal to submit to tariff pressure and its selective use of countervailing tariffs to bring the US to the negotiating table. They also note that the US makes up less than 14 per cent of China's total export market, and point to the integration of US manufacturing with international supply chains, most of which rely on Chinese components and participation.
The fact remains that China is the largest market for cars, and the major source of profits for all US carmakers. Closing this market destroys the profitability of US carmakers, and there is no substitute market in the US.
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To succeed, traders must trade what they see on the price chart, rather than what they might believe about the market condition. Investors have a more unenviable task, because they make investment decisions based on their long-term expectation of how the market would behave. It is easier when perception and reality coincide, and more difficult when they diverge.
In all situations, the chart of index activity provides a closer approximation to the reality of the economy. There are two places to look at in this battle between economies. The first is the broad S&P 500 index. It is not perfect because it comprises only the top 500 stocks. This means the S&P is based on survivor bias, because the index components include only winners, so it gives the appearance of always rising. The second is the Shanghai Index, which comprises all stocks trading on the Shanghai Exchange.
The S&P 500 Index is dominated by the rounding-top pattern. The rapid pullback in April exceeded the chart pattern projection targets for a 20 per cent fall. This is very bearish.
The rebound from support near 5,200 does not mean the influence of the pattern on the market has ended. The rebound rally is not yet a trend change.
The arc of the rounding top is projected to the right. Technically, the Index needs to move above this projected value, now around 6,050, before we can say a new uptrend is in place. Until the index breaks above the pattern line, the best that can be said is that the market is in a rally. This means the market may retreat and again test the 5,200 support level.
The Shanghai Index has traded in a broad sideways trading band between 3,150 and 3,400 since October 2024. The three breakouts above 3,400 have been weak. The fall below 3,150 was also weak in the sense that it was followed by a rapid recovery. The 3,300 level has acted both as a support and resistance feature in this broader trading band.
The rally rebound has stalled and is consolidating around this level. From the US perspective, it indicates an unexpected level of resilience.
The consolidation carries with it the potential to break on the upside and move towards longer-term resistance near 3,400. A successful break above this level has the next resistance target near the previous high at 3,670. Any retreat from current levels has historical support near 3,150, or a fall of around 4 per cent. A retreat to these levels would not signal a collapse of the Chinese economy because it would be consistent with the normal ranging behaviour of the index over the past seven months.
The opportunity presented by the gap between perception and reality is that traders have the choice of going long while they are prepared to exit the trade quickly as the market pulls back. Investors may use dips as a buying opportunity and hedge these positions at rally peaks.
The charts suggest that the reality is that the US market has a bear lurking in the background because the China market shows unexpected resilience.
The writer is a financial technical analysis specialist, equity and derivatives trader and author
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