The Chinese and U.S. stock markets are going in opposite directions.
An intensifying crackdown against leverage in Asia’s biggest economy has rocked the hither-to unflappable Shanghai Composite Index over the past week, sending it to a three-month low last session. In the U.S., the largest equity market is embracing a risk rally spurred by the French election, with the S&P 500 Index continuing to build on reflation-trade gains ignited by Donald Trump’s November victory.
The divergence means the two markets are the least in tune since August 2008 -- just before the collapse of Lehman Brothers Holdings Inc. unleashed chaos on the global financial system.
Chinese officials have mainly kept mainland stocks on a tight rein after routs in mid-2015 and the start of 2016 reverberated through world financial markets. Until Monday’s 1.4 percent slump, the Shanghai Composite Index hadn’t fallen more than 1 percent for 86 trading days.
As Beijing’s focus on reducing risk in the financial system shifted from money-market tightening and reducing leverage to containing speculation and irregular trading, the two markets starting moving in opposite directions in the past month.
In one sense, it’s a sign that investors overseas aren’t as worried about Chinese market ructions as they were in previous years -- perhaps partly thanks to underlying strength in China’s economy. Given how mainland stocks have become increasingly linked to global markets, however, the divergence may prove to be a short-term phenomenon, according to Daniel So, a strategist at CMB International Securities Ltd. in Hong Kong.
“The Chinese government is squeezing speculation out of the market and while investors adjust, it will inevitably lag behind other parts of the world," So said.
The apt opening for my comment on the article above is this quote from the memorable Benjamin Graham:
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
In the short run market moves are a matter of confidence. If a sufficient number of influential investors in the market crowd are feeling optimistic, they will buy. When others see the market rising they will also be tempted to buy in what becomes a self-feeding bullish trend. This will continue until most investors interested in the trend are already long.
While the market holds its ground for a short period, most investors will remain hopeful. However, when the market has clearly paused for longer than earlier on within the trend, some investors will be tempted to close their position. When the market has fallen back more sharply than previously seen, others will become pessimistic and also sell, causing a bearish trend to form which retraces more of the previous advance.
International investors face many more choices and this can be confusing. A practical way to monitor these markets is by looking at weekly price charts for the indices of interest, showing at least 10-years of back history for perspective. They will quickly reveal Benjamin Graham’s voting machine results in terms of relative strength or weakness over the short to lengthy medium term. Those longer term charts will also show bullish or bearish weighing machine characteristics.
So which stock markets look the most interesting?
Wall Street, shown by the diversified S&P 500 Index, has been a leading force in terms of stock market recovery since early 2009. However, by far the most dominant sector is technology, as you can see from the Nasdaq 100 Index. Additionally, the Nasdaq Biotechnology Index, which led until becoming quite overextended in mid-2015, has been building support for the last fifteen months. A sustained push above 3250 would indicate that it is coming back into form.
In Asia, India’s Nifty 50 is the leading big market index. Japan is also doing well although the Nikkei 225 is lagging way behind TSE2 which is the Tokyo Stock Exchange Second Section Index. It is currently consolidating the recent surge to 6000. China’s Shanghai A-Shares Index will perform when the government next creates favourable monetary conditions.
In the European Union’s Eurozone, Germany’s DAX Index is the safest house in a troubled neighbourhood.
Stock markets are having a good week, starting with a relief rally because France did not send two anti-EU candidates into the second round, and the fresh-faced former Rothschild banker certainly looks like a safe pair of hands, at least by French political standards. As for Trump, he is being managed - sort of - and his tax policies have returned to centre stage, at least in terms of discussion. This has understandably excited Wall Street and lowered concern over valuations.
Looking ahead, we can expect seasonal factors during the rest of 1Q and 2Q to provide further reactions. More importantly, the gradual return to interest rate normalization, currently led by the USA, is likely to increase volatility over the next several years. Nevertheless, the markets mentioned above should have a good chance of avoiding disasters. I also think they are among the best candidates to maintain relative strength over the next decade and more. Among sectors the long-term potential for technology and biotechnology remains exceptional.Back to top