By Elliot Turner
Since Chinese markets peaked in early November preceding their 8-10% pull in, I have seen many point out that this portends ominously for U.S. markets. As the story goes, cyclical tops and bottoms have emerged first in China and before traveling to the United States.
This is a neat little narrative that fits cozily into the notion that China is the primary producer of goods for the United States and its markets are most euphoric during major inventory builds in the U.S., while U.S. equity markets are most euphoric during bouts of high domestic consumer confidence. Tied into this narrative is the idea that Chinese markets therefore lead U.S. markets on the charts.
All that being said, is there really a relevant relationship between cyclical peaks and troughs in Chinese and U.S. markets?
The Charts Might Have an Answer
Since China is the supposed “leader,” let’s look at it first:
And the S&P as represented by the S&P (SPY):
The charts both start in June of 2009 and the circles in each are at the same spots time-wise in order to highlight key inflection points in one country or the other. This should help provide an easy visual for symmetry between the charts.
So what are the key inflection points on these charts? China recorded its first Financial Crisis cyclical peak in November of 2009, while U.S. markets barely registered a hiccup at that point. It took Chinese markets until November of this year to break above the 2009 high. Meanwhile, U.S. markets registered a cyclical peak in late January of 2010; however, that cyclical peak was broken to the upside by March. Despite a summer swoon, U.S. markets have spent a significant amount of time above that first cyclical peak, while Chinese markets have spent nary a week there.
The cyclical top in the U.S. off of the March 2009 bottom occurred in April of 2010. At that point, China also registered a short-term top; however, the corresponding Chinese inflection point was not a cyclical top, but rather the first in a series of lower highs.
Many point out that Chinese markets bottomed in late October/early November of 2008, while U.S. markets bottomed in March of 2009 -- a time frame that is not represented on these particular charts. This is apparently proof-positive to people that Chinese markets do in fact lead U.S. markets. However, this point of fact varies significantly, depending on your reference point.
The NASDAQ bottomed at roughly the exact same time as Chinese markets, and this leads us to two important clues. First, technology sub-sectors, of which China boasts many, bottomed well before others. Second, the move down to the March 2009 lows was driven primarily by rampant weakness across the financial sector.
Perhaps more importantly, when U.S. equity markets peaked in mid-October 2007, Chinese markets surged ahead for another few weeks before putting in place its own cyclical top and reversing course. Is that really leadership?
Pulling it All Together
It’s hard to formulate any sort of concrete conclusion here based on leadership or lack thereof. The relationship between tops and bottoms is far more random than one would think before looking closely at the charts. It’s a good story, but not much more than that. In fact, I’d argue that the driving force behind the assertion of a leading relationship between Chinese and U.S. equity markets is twofold: An overabundance of short-termism in market analysis, and the need for every top to be “the” top and every bottom “the” bottom.
What we need to remember in times like these is that not everything happens in absolutes. When people are looking for evidence that this may be “the” top, they can manipulate what is seemingly random to sound like an impressive and conclusive argument. If people simply accept the fact that the market moves in waves, that no move is one-dimensional, that in markets moving higher there will be hiccups along the way, then the framework for analysis leads to a more pragmatic approach.
Fundamentally speaking, it would make more sense for U.S. markets to lead Chinese markets -- not necessarily on a total returns basis, but on a directional one. Demand for Chinese products is driven primarily at this point in time by demand from the United States, and that very fact makes Chinese companies reliant on American consumers. This will continue to be so until organic, domestic demand in China increases substantially.
One fact, however, is abundantly clear: U.S. markets have significantly outperformed Chinese markets since November of last year and throughout much of 2010 -- and appear to be doing so right now as well.