Failed Correlation Trade Suggest China's Slump Could Be A Pause

Technically yes China's Shanghai index (SSEC) is in a bear market. Losses that reach 20% is technically defined as a bear market.

The SSEC could probably be haunted by the September-October seasonal stock market weakness.

In addition, many have used the Baltic Dry Index (BDI) as a "rational" for a major inflection point on China's stock market aside from the purported policy induced slowdown in credit flows.

Do we share the view that China's stocks will continue to collapse? No.

In contrast to the past where a decline in China's market had prompted for a rise in the US dollar index (for example see April) or our correlation trade, the recent slump have ironically been opposite-the US dollar Index fell!

Our correlation trade extrapolates to falling global stock markets and commodities along with a rising US dollar index (flight to safety) where a higher US dollar index would have signaled 'tightening liquidity'.

But this doesn't seem so. Hence the continued buoyancy in most stock markets.

The US stock markets ended lower last night but hardly reflected on SSEC's crash.

So if the US dollar index persist on weakening amidst sagging global markets, they are likely to signify an "interim pause" and not a major reason for a collapse.

And this should also apply to commodities.

As we see from the Russian experience, where the RTSI earlier fell by 30%, the Russian benchmark have managed to recover most of its loses and now trades above the 50-day moving averages.

This looks likely the paradigm for the SSEC than for a major meltdown.

Global Stock Market Performance Update: Despite China's Decline, Emerging Markets Dominate

No trend goes in a straight line. That's the fundamental truism of the marketplace.

Yet some analysts have taken China's monstrous 2 week decline as something to gloat on.

True, China has entered the bear market cycle based on the 20% decline technical rule.

But it is unclear that she could suffer from the same fate of the 2008 meltdown. Yet, we won't bet on such idea, especially not when global policymakers have been targeting the asset markets.

Nonetheless here is the updated year to date global performance chart from Bespoke Investments.

From Bespoke Invest, (bold highlight theirs)

``After a 20% decline in a matter of days, China is now just the third best performing BRIC (Brazil, Russia, India, China) country year to date. Russia is up 57.24% year to date, India is up 53.51%, and China is up 52.99%. But it could be worse for China. At least they're not down 50% year to date like Ghana.

``You can tell how much China has sold off versus the rest of the world by looking at its percentage from its 50-day moving average. China is one of just 5 countries that are up year to date and currently trading below their 50-day moving averages, and it is the second furthest below its 50-day (-10.34%) out of all countries behind only Nigeria (-11.97%)."

As we discussed in Global Stock Market Performance Update: Proof of Rotational Effects and Tight Correlations, it has been quite evident that the pricing of global stocks appears to be in rotation, which clearly is a symptom of global inflation dynamics.

Moreover, despite the precipitate 20% decline in China, they remain at the tenth spot among the world's best performers.

China's decline simply brings the BRIC (Russia-7th, India- 9th and Brazil 11th) in a tight pack of the race.

Recall earlier too that Russia fell 30% before rebounding (top window) but has presently been creeping higher. The same actions had been realized in India (BSE) and Brazil (BVSP) but both have recovered strongly.

In contrast, China's rise has been vertiginious or without any major correction since February. So the sharp decline seems much desired, as to normalize its long term trend. The same dynamics seen in its peers are likely to take hold on China's Shanghai index once it establishes a bottom.

Yet regardless of China's recent fate, the BRIC and emerging markets has simply outclassed, by a mile, developed economies, where 9 of the top 20 have been Asian bourses (by pecking order: Indonesia, Sri Lanka, Vietnam, India, China, Taiwan, Philippines, Singapore, Thailand and Hong Kong).

So it would seem like a pointless exercise to gloat over China's recent losses. In horse racing lingo, China's recent decline could be interpreted as part of the "handicapping" relative to developed economies.

Anyway here is the chart (courtesy of Bloomberg) of the world's topnotch equity bellwether-Peru.

If there is anything to be discerned from the above, no trend goes in a straight line.

Global Stock Market Performance Update: Proof of Rotational Effects and Tight Correlations

This is an example of how experts use specific time frames to prove a point.

This from Bespoke Invest,

(bold highlights mine)

``The S&P 500 is up 11.24% since July 10th, which is a significant move in such a short period of time. The recent gains also put the index up nicely at 8.28% year to date. As shown below, the US has performed well relative to the rest of the world. Since July 10th, it ranks 22nd out of 82 countries. Russia is up the most with a gain of 24.23%, followed by Hungary, Poland, Norway, Romania, and Germany. Middle and Eastern European countries have seen some of the biggest gains in recent weeks."

Adds Bespoke, ``While China has been the second best performing country (behind Peru) year to date, it is only up 10.32% since July 10th. This is better than most countries, but it hasn't been the worldwide leader that it was earlier in the year. Five of the G-7 countries have outperformed China, and all seven G-7 countries are in the top 50% in terms of performance. This is a sign that developed markets have been holding their own against emerging markets in recent weeks. Only ten out of 82 countries are down since July 10th, with Slovakia leading the way at -5.67%."

We are grateful to Bespoke for their wonderful graphics.

However, with China's year to date gains at a mindboggling 88.66% and with the Shanghai benchmark at grossly overbought conditions, it would be a puzzle or an irony to expect a continuation of such torrid pace of advances or even make a worthwhile comparison. 88% versus 9% (year-to-date) is just a wide wide chasm.

As we earlier wrote in Global Stock Market Performance Update: Rotational Effects and Tight Correlations

``If global markets have been driven by liquidity or monetary forces or inflation dynamics then it is quite obvious that there will be rotational effects and secondly, for the early movers some tight correlation, as global liquidity transmission interlinks divergent markets."

Hence, our views seem to get validated where we appear to be indeed witnessing rotational effects from inflationary policies as the market leadership has temporarily switched from (leaders) emerging markets to the (laggards) developing markets.

Another, as Bespoke likewise observed, only 10 out of 82 since July 10th are down, or 17 out of 82 global benchmarks on a year-to-date basis-signifies further proof of the "global liquidity transmission interlinks divergent markets", we earlier posited. Market gains seem to broadening on a worldwide basis, but not all.

Russia's RTS outperformance appear to be a function of a typical bullmarket trend.

As we commented in the same article, ``Russia's hefty decline exhibits overheating. The Russian benchmark is still the 5th best year to date performer IN SPITE of the recent (21%) downturn. It trails Peru, Sri Lanka, China and India."

Indeed, after a 50% fibonacci retracement since the March lows, Russia has used its recent reprieve and the opportune windows provide by developed markets as fulcrum to stage another gala rendition (even at the face of a mighty performance by developed economies.)

Bottom line: ``developed markets have been holding their own against emerging markets" because of the rotational effects and global liquidity transmission of the global inflation dynamics more than representative of idiosyncratic strength or traits.

At the end of the day, emerging markets has still patently outperformed its developed counterparts under present "ultra loose monetary" conditions.

Global Stock Market Performance Update: Rotational Effects and Tight Correlations

Another fantastic chart from Bespoke Invest giving us an update on the recent turn of events.

According to Bespoke (bold highlight mine),``Bloomberg's World Index made a rally high on June 2nd. Below we highlight the stock market performance for 83 countries since June 2nd and year to date. Since the 2nd, 14 countries have seen stock prices continue to rise, while the other 69 have seen prices fall. Lebanon, Kenya, Sri Lanka, and Mauritius are the only countries with double-digit percentage gains. The biggest country to show gains during a time when global stocks have struggled is China. China's Shanghai Composite has rallied 6.18%. The other three BRIC countries have not fared as well. India is down 3.7%, Brazil is down 7.82%, and Russia is down a whopping 21%. Russia has been the second worst performing country during the recent downturn.

``Looking at G-7 countries, Japan has held up the best since June 2nd with a decline of 1.59%. The US has been the second best at -5.21%, followed by the UK, Canada, France, Germany, and then Italy."

My comment:

If global markets have been driven by liquidity or monetary forces or inflation dynamics then it is quite obvious that there will be rotational effects and secondly, for the early movers some tight correlation, as global liquidity transmission interlinks divergent markets.

Notice that most of the today's (from June 2nd) topnotch performers (e.g. Kenya, Bangladesh, Latvia, Slovakia, Oman, Morroco, Bostwana et. al.) have had sluggish year to date gains or had earlier underperformed.

Additionally, the decline of the BRICs (except China) have been in parallel with the decline of the front running EM leaders, as well as, having tracked OECD market performance in terms of price direction over the interim.

Russia's hefty decline exhibits overheating. The Russian benchmark is still the 5th best year to date performer IN SPITE of the recent (21%) downturn. It trails Peru, Sri Lanka, China and India.

This implies of an ongoing rotation, where previous laggards are now ahead, while former leaders appear to undergo a hiatus.

Next, despite the recent correction, Emerging Markets continue to outperform developed economies, albeit at different rates-again an obvious impact from inflation dynamics-as that of being relative.

A Government Cardinal Sin That Results To A Bear Market? War!

What is one of the government prompted cardinal sins that results to a bear market? The answer is War! We have dealt with this in our past article, Phisix: Learning From the Lessons of Financial History.

So now it appears we have a LIVE unfolding showcase: Russian assets have been collapsing since the military conflict with Georgia erupted!

Courtesy of Danske Bank

From Lars Christensen and Lars Rasmussen of Danske Bank (highlight mine),

``Russia’s financial markets remain under pressure today following the news. Performance has been negative in FX, fixed income and equity markets, and among derivatives. The Russian rouble (RUB) at one point weakened more than 1.3% against its dual currency basket (45% EUR and 55% USD) to trade around 30.10. The Russian central bank (CBR) has since stepped in to support the currency. The RUB basket currently ranges between 29.70-29.90, a few percentage points weaker than last week.

``Meanwhile, Russian share indexes have hit their lowest levels for almost two years. Russia's benchmark RTS stock index fell more than 4% this morning, to its lowest level since November 2006, although it has rebounded somewhat in the last couple of hours. Overall, Russian equities are down more than 30% from their peak in mid-May.

``Going forward, the Russian markets will remain under pressure for as long as there is no move towards a resolution of the conflict. In addition, further falls in oil prices could add to the downward pressure on Russian assets. Caution is thus clearly warranted in the Russian financial markets.”

Additional observation…

From the New York Times,

``Mr. Saakashivili, the Georgian president, said Russia’s oil riches and desire to assert economic leverage over Europe and the West had emboldened Kremlin country to attack. Georgia is a transit country for oil and natural gas exports from the former Soviet Union that threatens Russia’s near monopoly.

“They need control of energy routes,” Mr. Saakashvili said. “They need sea ports. They need transportation infrastructure. And primarily, they want to get rid of us. ”

Hmmmm. It seems to sound more like a conflict premised on commodity geopolitics!