The U.S. and Chinese stock markets have been remarkably correlated over the last two years, with Chinese price action leading U.S. stock market moves by about three months, highlights Citi’s Tobias Levkovich in a note.
The Chinese equity market has become a tightly correlated three-month lead indicator for the S&P 500 over the past three years as the investment community has looked to China as a significant driver for global economic trends essentially caused indirectly by exports to developed regions. In this context, it does seem odd to some extent that emerging market equity mutual fund inflows continue to be robust even as individual investors flee domestic equity funds due to local economic concerns and even as the economies in question are needed to sustain the growth of developing economies’ GDP. Nonetheless, the interconnected nature of worldwide business activity has made the Shanghai stock exchange quite relevant.
It’s almost as if the U.S. market started following China ever since the U.S. housing market began to weaken in 2007:
If the relationship holds, then U.S. stocks should be bottoming around now given the recent Chinese bounce:
The Chinese stock index hit its recent lows back in late June/early July and given the respectable correlation as a lead indicator, suggests that US equities should hit their lows in the September/October time period and then begin to rebound, which interestingly enough is around the seasonal trough seen in the S&P 500 over time. Notably, September is often seen as the worst month for major US equity indices but we suspect that its common knowledge facet has made it less than reliable as it gets “baked in” to the existing market sentiment and thus the lows already may have been seen.
To be honest, we’re extremely sceptical of these kinds of short-term correlations. They tend to exist until they simply don’t for whatever new reason, thus relying on them isn’t the most robust trading process. However, should the U.S. market bottom soon then correlation believers will be laughing at our scepticism.
(Via Citi, Tobias Levkovich, Chart of the Month, 7 September 2010)
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