China – Ready To Join The Union

We’ve been noting how breadth continues to contract on the NYSE – as the market seeks to overtake the most recent highs, it is once again being driven by fewer and fewer leaders (for background on breadth see here).

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To my way of thinking, weakening breadth is a reflection of progressively more companies bumping up against valuation constraints (that is, individual share prices are becoming stretched relative to expected earnings).

If we look inside which sectors are leading the US markets higher, it becomes apparent that those companies that benefit from a weaker US$ are outperforming – energy and commodities stand out. Still we can’t argue with the performance of the market as a whole:

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This got me thinking once again about the transmission mechanism for QE. The Fed has been keen to emphasise the ‘portfolio balance channel’ (see here for how the POMO works). But as we have argued before there is another aspect to promoting ‘financial conditions supportive of recovery’ – the decline in the USD (for a summary of the argument see here). In that context, contrast the gyrations in the US$ with those in breadth:

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When the US$ is rising, breadth tends to fall and vice versa. Perhaps there are two forces are at work here:

1) Earnings of at least some US companies are materially effected by changes in the US$.

2) The attractiveness of US assets to international (non-US denominated) investors will vary with changes in the US$

So what has this got to do with China? I’m glad you asked. Please consider how breadth on the NYSE is tracking relative to the Shanghai Composite index:

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All smoke and mirrors perhaps, but the swings and roundabouts in the Chinese index do seem to have a strange bed-fellow in the breadth of the US equity markets. Is this an outpouring of the same US$ effect that we noted above. Seems reasonable – given that 1) China runs a peg against the US$ and 2) China is an export driven economy.  But equally, the US$ effect may have found expression in the same commodity trade that has taken the world by storm – this would be consistent with the anecdotal evidence out of the commodities markets there.

As always it is not a simple matter to get some hard facts on the relative sector performance in China (check out the Shanghai Stock Exchange website here). But that won’t stop us – I guess it is remiss of me not to have sought this out before…

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