China's economy slowly winds down

China has put up annual GDP growth of more than 7% this year, slower than previous years, but still impressive. M2 continues to grow at mid-double digits rates. The Shanghai Composite Index, meanwhile, is probing new 3 year lows and is within striking distance of the crisis lows! The actual low set on November 4, 2008 at 1706.7, a decline of 13.8% from today's close, a significant decline, but not unimaginable. Currently, at a November 2012 close of 1980, the Shanghai Composite is trading at levels last seen in November, December and January of 2008-2009.

I had to readjust the axis on the Shanghai Composite for the chart below, it was set at 2000. This shows continued deceleration in M2 and the sliding stock market.

Where is this headed? Some economic indicators are turning up, but the money supply figures indicate things are edging closer to deflation. What's most interesting is the hot money from QE3 flowed into China, yet didn't manage to push money supply higher; instead we saw the third month-on-month decline in M2 this year.

Technically, the 2008 lows are strong support. Psychologically, they are strong as well. However, it is a fragile psychology. The initial reaction will be: with 4 years of strong economic growth, why are stocks at 2008 crisis levels? Chinese stocks are some of the cheapest in the world, now is the time to buy!

The next reaction will be: what is wrong? If the answer to that question is debt and unsustainable earnings based on real estate and other speculative projects, then the lows could be breached with authority.

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