Is A China-Taiwan Conflict Likely? Watch The Region’s Stock Market Indexes

Editor’s note: Seeking Alpha is proud to welcome Elliott Wave International as a new contributing analyst. You can become one too! Share your best investment idea by submitting your article for review to our editors. Get published, earn money, and unlock exclusive SA Premium access. Click here to find out more »

By Mark Galasiewski, Elliott Wave International

The U.S. government in May 2024 sanctioned 300 Chinese entities for supplying machine tools and parts to Russia for its war against Ukraine, while Russian President Vladimir Putin visited China in May and North Korea in June. In turn, I found myself thinking about how tensions between China and the United States could lead to open conflict, specifically over Taiwan.

The likelihood of conflict depends in part on the region’s social mood, as reflected in Asia’s stock market indexes. When the social mood is negative-indicated by declining stock prices-countries are more likely to behave aggressively.

Tensions in the Taiwan Strait have been high. In May, China conducted a military drill that sent 111 warplanes plus several navy destroyers and frigates close to Taiwan and its outer islands. In July, Beijing conducted at least 439 military incursions into Taiwan’s Air Defense Identification Zone, surpassing all previous months except August 2022.

Yet, China appeared to end the provocative moves quickly, much like Iran quickly ended its reprisal drone attack on Israel in April and Hezbollah quickly ended its reprisal attacks on Israel in August. All those examples reflect a desire to limit the scope of new conflicts, consistent with the improving social mood and burgeoning rally in emerging markets.

As our “Bull versus Bear” chart shows, the mood in Taiwan remains positive amid the global tech boom: The Taiwan Index has continued rising in recent years despite China’s threats. In contrast, the mood in China remains severely negative, as reflected in the Shanghai Composite’s corrective pattern from the 2007 high, which is known in Elliott Wave terminology as a contracting triangle. Social conflicts do not always occur toward the end of corrective patterns, but the completion of the pattern does raise the risk of Chinese aggression-or at the least increases the risk of accidents and miscalculations. As Singapore’s Deputy Prime Minister Gan Kim Yong said recently, bad outcomes tend to follow during periods “when each side views the other as an adversary.”

Some geopolitical observers frame the Russia-Ukraine conflict as a proxy battle in a new Cold War between the United States and its democratic allies versus the China-dominated axis of autocratic states that includes Russia, North Korea, and Iran.

Long-term charts offer perspective.

In 2020, the MSCI Asia-Pacific Ex-Japan Index ended a 26-year contracting triangle, while the MSCI World Ex-U.S. Index ended its own, similar 20-year-long contracting triangle. This two-decade period is comparable to the 1929-1949 corrective period in the U.S. stock market. The COVID-19 pandemic erupted toward the end of the triangles, much like the 1948-1955 polio epidemic spread across the globe and killed half a million people a year at its peak.

The first proxy battle in the current war-Russia-Ukraine-erupted two years post-COVID-19 during the correction in the index, much like the first proxy battle-the Korean War-in the earlier Cold War erupted in 1950 and lasted until 1953. The Russia-Ukraine war could follow that precedent by ending in a stalemate sooner than most observers imagine, as the improving social mood underlying the developing bull market in world ex-U.S. stocks engenders years of relative peace. Then, once China becomes much stronger militarily, the next proxy battle in the Cold War rivalry-perhaps over Taiwan-would be analogous to the Vietnam War when the U.S. dramatically escalated the fighting in 1965 and pulled out eight years later, as the communist government of North Vietnam, in turn, took over South Vietnam to reunite the country.

We’re watching the region’s stock market indexes closely.