Trading Nation

Ignoring Chinese stocks? You’re living in the past

The China market connection

A plunge in Chinese stocks has been blamed for the awful beginning to the year that U.S. stocks have suffered. And while many have protested that this is an overreaction, given that Chinese stocks haven't tended to enjoy a tight relationship with American equities, those people appear to be living in the past.

To be sure, it is true that over the past five years, there has been almost no relationship between the and the Shanghai composite. Over the past five years, the correlation between the weekly moves made by the two indexes is 0.05 — essentially nothing. Compare that to the 0.79 correlation between the S&P and the German DAX index, or 0.61 between the S&P and Japan's Nikkei. (Recall that correlations run from -1 to 1, with 0 indicating no relationship, 1 expressing perfect correlation, and -1 reflecting exact opposition.)

But something strange has happened on the way to U.S.-Chinese indifference.

Starting with the August crash in Chinese markets after that country's currency devaluation, the correlation between the S&P and the Shanghai composite has risen precipitously. Since then, the relationship has simply gotten tighter and tighter — and in 2016, the one-year correlation of weekly moves has reached fresh heights.

It's not as if the world has simply gotten more global. In fact, the S&P's correlation to the Nikkei has remained flat, and the relationship between the S&P and the DAX is now looser.

Weekly Correlation 5-year 2-year 1-year
S&P 500 / Shanghai Composite0.0460.2470.315
S&P 500 / DAX0.7860.6710.637
S&P 500 / Nikkei0.6130.6130.619
S&P 500 / Australian ASX 2000.6490.6570.709
S&P 500 / MSCI Kenya0.096-0.039-0.107

The trouble with mapping relationships between two volatile data sets in an ever-changing world is that the relationship is itself highly volatile, as can be seen above.

But for that same reason, saying "this hasn't mattered in the past" is a poor excuse for ignoring that same thing now.