Note from dshort: Following up on Chris Kimble's post this morning on the Shanghai Composite, I've updated the charts below through today's 2.37% decline in the index.

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Today, all eyes remain focused on the eurozone financial crisis, the inevitable ripple effect of the Libor scandal, and the potential drag on US markets. And of course we in the US are at the start of earnings season, with Alcoa set to report after the bell. But what caught my eye this morning was the Shanghai Composite, which is down 11.78% from its 2012 interim high on March 2nd.

My friend and occasional guest contributor Chris Kimble came up with the notion of an Eiffel Tower formation as an emblematic way to discuss asset bubbles, which was featured in a guest commentary from last summer. The behavior of the Shanghai index over a two-year period beginning in late 2006 is a classic example, as the first two charts illustrate.

 

 

With an arithmetic vertical axis, the Eiffel analogy is rather amazing.

 

 

But let's switch to a log scale vertical axis and shorten the timeframe to look at the numbers. We diminish the playful tower analogy, but we get a more accurate visual representation of the relative values of peaks and troughs in the price.

 

 

The horizontal red line shows the current level of the index. At today's close the index is a mere 1.04% above the interim low on January 5th. Should the index plunge below this level, the next lower trough, the November 2008 low, is over 21% below the latest close.

Where is this index headed in the near to intermediate term? The ongoing economic turmoil in the eurozone, China's biggest export market, continues to be a significant problem, and signs of a slowing domestic economy are exacerbating the problem. However, over the next few years, Chinese demographics should provide a bit of cushion.

In developed countries, the peak earning years are ages 45-54, with the 45-49 cohort as the peak spenders. Assuming China is moving toward a similar pattern (an assumption I make with caution), the earning-spending cohorts will grow significantly. Unless China's housing bubble triggers a widespread retrenchment and a loss of consumer confidence, demographics, at least over the next 5-10 years, should work in China's favor, driven by home-grown consumption.

One thing is certain. We'll want to keep a close eye on the Shanghai Composite in the months ahead.