This column was originally published on RealMoney on July 25 at 12:06 p.m. EDT.
It will take months for equity traders to get their hands around China's decision to end the yuan's peg to the dollar. But we saw its initial effect on Thursday when dozens of stocks sold off as soon as the market opened. The sharp declines caught many traders by surprise.
That day's volatility was heightened by new terrorist bombings in London and the second day of
Chairman Alan Greenspan's congressional testimony.
These events made it harder to gauge the direct impact of the announcement. But the emerging themes finally sorted themselves out by the closing bell.
The currency shift is expected to undermine profits at companies dependent on cheap imports from that part of the world. I got a quick education on the subject because I was holding
at the time of the statement. My nice profit turned into a break-even exit just a few minutes after the open.
American retailers buy a ton of Chinese clothing and household goods. The revaluation raises questions about the sector's ability to expand gross margins in the months ahead. Kohl's and dozens of other retailers got caught in a "sell now, ask questions later" mindset on Thursday morning.
The good news is that many American companies buy Chinese goods in American dollars. This will provide them with at least short-term protection. But the yuan shift will eventually find its way into the cost of delivering all types of Asian products, regardless of current contract arrangements.
Clearly, it will take time before we see China's decision fully reflected in stock prices. Unfortunately, its incremental nature adds to the confusion.
Was the edict the first of many currency adjustments, or are Eastern politicians just gaming the adverse response to
Let's focus on the possible reactions to, rather than finding reasons for, the change in policy. First, it's well understood that retailers will be affected, along with other companies that have significant Chinese exposure. In this regard, let's step back and look at Kohl's broader price pattern.
It's obvious the late-week selloff did little to undermine Kohl's strong uptrend. The stock printed a bull hammer on Friday and looks ready to take another run at the highs. This strong recovery was repeated across the broad sector as last week ended.
Notably, the volume pattern shows little impact from the two-day pullback. Investor participation was below average and on-balance volume (OBV) hardly budged. It's tough to see anything but a buying opportunity when looking at this chart.
Red Flags in Retail
But the broader
exchange-traded fund is now flashing several warning signs. The stock rallied to resistance at $102 midweek and gapped down following China's announcement. The good news is the pattern shows a multiyear cup-and-handle pattern. The bad news is that accumulation is very weak for an issue that rallied for the last 12 weeks.
This suggests the sector could start a four- to six-week correction before taking a sustained run over the breakout level. In this regard, watch out for a retail stock reversal in the next one to three days, as strong hands come in and sell out. Higher volume on that decline would confirm that the Chinese revaluation is bad news for retailers.
Utes Feel the Pain
Ten-year Treasury yields rose in response to the currency shift. In turn, utility stocks sold off sharply last week. The group had an especially bad session on Thursday, with the
( UTH) falling almost 2%. The timing was particularly bad because the UTH already shows a number of bearish divergences.
The ETF's relative strength has been falling since mid-June, despite higher prices. While the stock's accumulation remains healthy, the megacap Dow Jones Utility Index presents a different picture. At least one-third of its blue-chip components now show bearish distribution patterns.
My advice at this juncture is to watch the Utilities HOLDRs' parallel channel closely. A decline under Thursday's low will break the channel and start a correction that could last for at least several months.
A Direct Play
Are you looking for direct plays on China and its currency policies? Start with
iShares FTSE/Xinhua China
. A basket of 25 Chinese blue-chip stocks fill the core of this exchange-traded fund. The instrument broke out to an all-time high on Thursday's news. The best entry for long-term positions will come on a pullback to $58.
So what's the bottom line on China's currency decision? First, we haven't seen its full impact yet. Second, analysts are scrambling to sort out all the winners and losers. Third, Thursday's knee-jerk reaction may foreshadow larger-scale equity selling in the weeks ahead.
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Alan Farley is a professional trader and author of
The Master Swing Trader
. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback;
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