Much head-scratching has occurred in the financial media in regards to the negative divergence between the Chinese equity markets and the U.S. equity markets. Why are the markets of the two largest economies in the world moving in opposite directions?
We don't know why. But it has happened before. And the similarities are striking.
From March 2003 to October 2005 (first shaded area), the Shanghai Exchange dropped 28% while the SP500 climbed 42%.
From October 2010 to April 2013 (second shaded area), the Shanghai Exchange dropped 27% while the SP500 climbed 35%.
What happened after October 2005? The negative divergence between the SP500 and the Shanghai Exchange ended with the Shanghai Exchange exploding to the upside, following and "catching up" to the SP500.
Note that after the negative divergence ended in October 2005, the SP500 went on to add another 24% before peaking in October 2007.
If history repeats itself, now would be an excellent time to buy Chinese equities, and we could assume that we still have another 24% upside in the SP500, which would put the index at 1,980 in about two years.
Caveat Emptor: history does not always repeat itself. But we have to admit that for whatever underlying economic reasons the pattern from 2003-2007 has already been half-repeated. Will the second half of the pattern follow suit?
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FXI over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.