What rebound? China’s huge number of oversold stocks signals equity market woes aren’t over

China stock benchmark’s breach of a key support level bodes ill for mainland equities, if historical data on the number of stocks seen as oversold by technical traders is any guide.

Escalating trade tension between China and the US sent the Shanghai Composite Index down by 3.8 per cent in Tuesday’s trading and put the gauge to close below the 3,000-point gateway for the first time since September 2016. While 54 per cent of the stocks on the 1,464-member benchmark have already dipped below the indicative oversold line, such breadth is insufficient to signal that the market is close to bottoming out soon.

Technical traders typically use the 14-day relative strength index to weigh the momentum of stocks. A reading above 70 indicates stocks are overbought and one below 30 signals being oversold.

Historical data that showed the battered stocks needed to make up at least 70 per cent on the Shanghai Composite before the gauge could even begin to reverse a downward spiral. During the 2015 market crash, 78 per cent of the stocks saw their relative strength index breached 30, and the proportion reached 70 per cent in the 2008 global financial crisis, according to Bloomberg data.

“The market hasn’t capitulated and it has yet to find a bottom,” said Wu Kan, a fund manager at Shanshan Finance in Shanghai. “Fundamentally speaking, we need to see the easing of the trade war and deleveraging, the two main factors that have weighed on the market, before we can talk about the bottoming out.”

Some of China’s biggest publicly-traded companies on the Shanghai bourse were also among the oversold companies. The list included Industrial Bank, China’s biggest train maker CRRC and Shanghai International Port Group, the operator of the world’s busiest port.

The current percentage of the oversold stocks on the Shanghai Composite is the second highest this year. Fifty-six per cent of the companies pierced through the oversold line in February when the threat of the trade war loomed large. A brief rebound ensued before it lost steam quickly and the market resumed its declines.

The Shanghai Composite is now the worst-performing benchmark among the world’s major stock markets this year with a 12 per cent loss. While policymakers are sticking to the financial deleveraging by curbing rampant development of its asset management industry, intensified trade friction is also dimming the economic growth outlook. US President Donald Trump threatened additional US$200 billion tariffs on Chinese goods on Tuesday in response to Beijing’s retaliatory US$50 billion tariffs.

Still, a short-term rebound on the Shanghai Composite may be likely. The 14-day relative strength index for the benchmark dropped to 25.9 on Tuesday, well below the reading of 30 suggesting stocks are being oversold. It recently traded at 2,907.82.

“The sell-off isn’t over as there’s still a small group of stocks that are holding up strength, such as Kweichow Moutai,” said Wei Wei, a trader at Huaxi Securities in Shanghai. “Only after these stocks are beaten down, will the real market bottom arrive.”