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CORRELATION ANALYSIS


Is The Tiger Losing Its Stripes?

07/27/12 09:48:55 AM
by Matt Blackman

Not long ago, Chinese growth dominated the financial news. What happened?

Security:   SSEC, SPY, PIN, RBL, BRXX
Position:   N/A

A year ago, the "Asian tiger's" economic growth story was impressive, to say the least. Over the past decade, the Chinese economy had been growing at an incredible average of 9% per year, making it the fastest-growing emerging market in terms of GDP in the 21st century.

But in 2011, the tiger began to show signs of strain. Property sales, a major driver of economic growth, had begun to slow. According to Jim Chanos of Kynikos Capital, construction accounted for 70% of Chinese GDP in 2011, and he predicted that China was heading for a fall that would take Asia and resource economies like Australia and Brazil with it, during a February 2011 CNBC interview.

Chanos presented a convincing fundamental case for the Chinese bubble (http://goo.gl/PBGPa ). But the solutions to the nation's massive debt, number of ghost cities, and other economic challenges will be neither easy nor quick. Those who blindly accepted Chinese GDP and economic reports without question are paying the price and it's in situations like this that technical analysis can prove most valuable.

FIGURE 1: SSEC, WEEKLY. The weekly chart comparing performance between the Shanghai Composite Index (SSEC-X) and the S&P 500 since the beginning of the stock rally in March 2009.
Graphic provided by: FreeStockCharts.com.
 
Figure 1 shows how Chinese stocks have been moving since March 2009. Not shown is the nearly 500% rise in stock prices from July 2005 to October 2007. Then between October 2007 and October 2008, the SSEC-X lost 72% of its value before beginning a new rally in November 2008, well ahead of US stocks. After doubling again by August 2009, the SSEC struggled and by the end of July 2012, the value of the Shanghai Composite had dropped by a third below its 2009 lows.

But what is perhaps more interesting than the bubble-bust cycle of Chinese stocks is the impact that it appears to have exerted on the stocks of other emerging markets. Indian stocks began dropping with SSEC in early 2011 but then began leading Chinese stocks lower. Meantime, Russian and Brazilian stocks continued to enjoy rallies before peaking in late 2011. Since then, it's been a volatile ride lower. See Figure 2.

FIGURE 2: SSEC. Here's a chart comparing the Chinese stocks (SSEC-X) with India (PIN), Russia (RBL), Brazil (BRXX), and the S&P 500 (SPY) since October 2010. Since peaking in November 2011, the SSEC has lost more than a third of its value.
Graphic provided by: FreeStockCharts.com.
 
The question that traders should be asking themselves is, how long before the challenges being felt in emerging markets exert the full effect on US stocks? It is a principle of intermarket analysis that no asset class or geographic region is truly independent -- all markets exert an effect on the others. It's only a question of when.

Suggested reading
Jim Chanos on the China Bubble:
http://www.moneyweek.com/news-and-charts/people-in-the-news/guru-watch/jim-chanos-on-the-china-bubble-10610

Hedge Fund Manager James Chanos on His Big Short in China:
http://www.huffingtonpost.com/maneet-ahuja/james-chanos-china_b_1605618.html



Matt Blackman

Matt Blackman is a full-time technical and financial writer and trader. He produces corporate and financial newsletters, and assists clients in getting published in the mainstream media. He is the host of TradeSystemGuru.com. Matt has earned the Chartered Market Technician (CMT) designation. Find out what stocks and futures Matt is watching on Twitter at www.twitter.com/RatioTrade

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