In today's
ever-more interrelated financial world, China's stock-market action is
growing increasingly influential everywhere else. As the globe spins, the
results of each day's stock trading in China often spill over into Europe and
then the States to affect sentiment. This impact is universal, but especially
pronounced in sectors China plays a major role in like commodities stocks.
Interestingly,
the recent breakdown in the US stock markets in late June was the latest
example of this China-driven sentiment bleedover. On Monday June 28th, the
flagship S&P 500 stock index (SPX) here in the States remained well above
its correction lows from 3 weeks earlier. But as China's stock markets opened
the next morning, a US non-profit organization released a downward revision
in its brand-new index of leading economic indicators for China. It claimed
it had made "a calculation error" weeks earlier.
The reaction in
Shanghai was fast and furious, China's flagship Shanghai Stock Exchange
Composite Index (SSEC) plunged 4.3% on Tuesday the 29th. It was this index's
worst selloff by far in nearly 6 weeks. Later that same day, this ugly
Chinese sentiment spilled over into the States and drove a 3.1% SPX selloff.
Not only was this the worst US down day since just before the correction
bounced in early June, but it drove the SPX to fresh new correction lows.
This led to more selling in the following days.
And when that
"news" alleging a slowing Chinese economy hit, commodities stocks
bore the brunt of the selling pressure worldwide. If China's economy was
really slowing as the US non-profit that didn't know how to properly build
spreadsheets suggested, it portended lower commodities demand. Since growth
in China is often the prime mover in the global commodities markets,
commodities-stock traders have to pay especially close attention to this
maturing economic giant.
Just as the
action in the US stock markets affects our collective economic outlook here,
the same is true in China. No matter where in the world they exist, when
stock markets are weak people automatically assume this means the local economy
is weakening. And vice versa if they are strong of course. So the fate of the
Shanghai Comp colors expectations about China's economic growth and hence its
future commodities demand. So often as goes Shanghai, so go commodities
stocks.
Global stock-market
sentiment is one big incestuous circle, so the SSEC often mirrors the SPX as
well. Consider the last cyclical
stock bear that cascaded into late 2008's infamous stock panic. The SPX
topped in early October 2007, and the SSEC followed about a week later. The
US stock panic climaxed in late November 2008, just a couple weeks after the
SSEC slammed into its own nadir. But as is often the case, Shanghai amplified
New York's moves. The SSEC plunged 72% to the SPX's 52% in that cyclical
bear.
Interestingly
commodities-stock performance over that span was much closer to the SSEC's
losses than the SPX's. Even most of the world's best elite commodities
producers saw their stocks plummet closer to 3/4ths than the general markets'
half here in the States. The horrendous losses in Shanghai, and their
implications for China's future commodities demand, certainly played an
important role in commodities stocks' panic psychology.
And I think this
is happening again today, the China-stock-market feedback loop depressing
commodities stocks far more than was reasonable during the recent SPX
correction from late April to early July. Over this event where the SPX shed
16%, the XLB ETF (materials stocks in the SPX) fell 20%, the XOI oil stocks
fell 22%, and elite market-darling copper miner Freeport McMoRan lost 26%.
Correction losses in smaller commodities stocks often ran between 33% and
50%! It was a bloodbath for this group.
Such
radically-oversold conditions always present big buying opportunities, so we
have been aggressively layering in to new high-potential commodities-stocks
trades in our subscription newsletters recently. And just as the China
sentiment angle contributed to the recent sharp commodities-stock selloff, it
is likely to really amplify the commodities-stock recovery as well. The
charts in this essay reveal why.
This first one
superimposes the Shanghai Comp over our usual benchmark SPX since early 2009,
the period that encompasses the cyclical bull
that emerged out of 2008's epic stock panic. The parallels between the
Chinese and American stock markets in the last couple years are fascinating
and illuminating. Every investor and speculator playing in the
commodities-stock realm needs to understand this important relationship.
Technically the
classic stock panic ended in November 2008, that is when extreme fear peaked
(87 VXO!) and panic selling exhausted itself. That is when the Shanghai Comp
bottomed as well. The subsequent March 2009 lows (51 VXO) here in the US
weren't an extension of the panic, but despair lows
driven by the Marxists who had just taken over Washington. In February 2009
they were self-righteously declaring that we overtaxed American investors
weren't paying enough taxes to those thieves in Washington!
It was despair
over these proposed massive new tax hikes on American investors courtesy of
the newly-empowered Marxist regime that drove the March 2009 SPX lows in the
US. Since China didn't face the same depressing regime change and resulting
punitive tax policies that we weathered in the States, the SSEC didn't follow
the SPX to new lows. Ever since then, the SSEC and SPX have usually tracked
pretty closely.
In early 2009
emerging from Washington's despair lows, the SPX and SSEC action mirrored
nearly perfectly. But last June, a big divergence developed. While the US
stock markets suffered their first material pullback of their young cyclical
bull, the Chinese stock markets rocketed higher. I can't recall
exactly what drove this particular SSEC spike, as last summer my attention
was riveted to the US stock markets and commodities (which corrected too
despite China's strength).
When the SSEC
peaked in early August 2009, it was up 64% since the SPX's March 2009
lows compared to 49% for the SPX itself. The SSEC had surged way ahead of the
SPX, taking the bull lead. And this was probably justified to some degree,
since China had fallen much farther than the US in the preceding cyclical
bear. The bigger the loss in a bear, the bigger the recovery bull after it ends.
Still, the SSEC was starting to look parabolic last summer and couldn't
sustain such a blistering rate of ascent.
So it corrected
sharply last August, plunging 23% over less than a month where the SPX rose
1%. With this Chinese-summer-rally anomaly resolving itself, once again the
SPX and SSEC were meandering together again for the rest of last year. These
indexes' movements in the final third of 2009 are nearly identical, as you
can see in this chart. But in early 2010, a new divergence started to develop.
While Shanghai
mirrored New York during the SPX's pullback ending in early February, the
biggest in the US cyclical bull to that point, China didn't recover like the
States did. While the SPX immediately began climbing higher into late April,
the SSEC lagged with an anemic rally. The performances of commodities and
their producers' stocks were much closer to the SSEC's sickly one than the
SPX's strong one. This sector largely sat out the relentless SPX rally from
February to April, really frustrating commodities-stock traders.
Though I watched
this latest divergence develop, its cause wasn't clear. Unfortunately I don't
speak or read Chinese and thus can't get a firsthand understanding of popular
zeitgeist among Chinese investors regarding their views on their stock
markets and their economy. I suspect this all tied into Europe fears though.
As sovereign-debt issues in Europe magnified in investors' psyches, everyone
thought Europe was sliding inexorably towards a cliff. And Europe is China's
largest export market, so a European implosion would hammer China.
Of course the
Europe fears were way overdone, creating a euro panic
that was likely a misinterpretation of the causality
between the SPX and US dollar. At any rate, when the SPX started
correcting in late April right after the blowout that spawned that depressing
Gulf oil gusher, the SSEC was already pretty weak. Right before that
correction when the SPX was up 80% from its March 2009 lows, the SSEC was
only up 41% over this same span. It was already languishing below its 200dma
when the US correction started.
With all markets
interrelated, the fearful sentiment in the States spilled over into China day
after day. The SSEC fell in concert with the SPX, but since the former
started at much worse levels its correction was much deeper. Parallel with
the SPX's 16% correction between late April and early July, the SSEC lost
25%! Once again China, a far-riskier market than the States, amplified the
moves in the American stock markets. The result was the huge gap
between the SSEC and SPX rendered above.
Just after the
SPX bottomed again on Friday July 2nd, the SSEC followed it lower on the next
trading day in China (Monday the 5th) despite the US markets being closed for
Independence Day. At its correction low, the SPX remained 51% above its March
2009 despair lows. Yet the SSEC, incredibly, was just 12% above its own
levels from that same day in March 2009! While the US stock markets were very
oversold, the Chinese stock markets were radically oversold.
All over the
world, commodities-futures traders and commodities-stock traders view the
state of the flagship Shanghai Comp as a proxy on the state of the Chinese
economy. And when you see how bad the SSEC has been faring lately, it is no
wonder that commodities and commodities stocks have been hit exceptionally
hard in the recent correction. If commodities' all-important marginal demand
growth out of China is in jeopardy, the commodities' secular-bull prospects
dim considerably.
But what if all
this mean reverts? For most of their parallel cyclical bulls to date,
the SSEC has tracked the SPX fairly closely. There have only been two
anomalies, and the first where the SSEC outperformed the SPX resulted in the
SSEC dropping back down to track the SPX again. And in today's second
anomaly, the SSEC has far underperformed the SPX. So if it mean
reverts the Chinese stock markets will rally dramatically, wildly outpacing
US gains, to catch up with the SPX again.
As the Shanghai
Comp soars, commodities traders around the globe will assume it reflects
highly on China's newly-awesome-again economic-growth prospects. The
commodities stocks that grew very oversold in the recent correction will
rocket higher to reflect this radically different sentiment. And as the euro
rallies (driven by
the US dollar) and Europe anxiety fades, the fears for China's exports
that weighed on its markets earlier this year will largely evaporate.
The SSEC has
fantastic potential to soar out of today's silly lows, and the bullish
sentiment it spawns should really light a fire under commodities stocks.
While China commodities sentiment is certainly not usually commodities'
primary driver, SSEC strength has the potential to really amplify a
commodities-stock rally driven by other factors. Its primary drivers will
likely be a recovering SPX resuming its cyclical bull and the resulting
weaker dollar. But a surging SSEC will certainly add to this favorable
sentiment.
As I was
exploring this thesis this week, I was wondering if this first chart with
non-zeroed axes was skewed. So I built another one that indexed both the SPX
and SSEC, from the former's March 2009 lows. This indexed perspective shows
the SPX and SSEC performance since that milestone in perfectly-comparable
percentage terms. This perspective not only confirmed my thesis, but reveals
today's massive gap is even larger than the first chart indicated.
From this
perfectly-comparable perspective, the latest anomalous divergence looks much
larger. And the first one during the summer of 2009 looks smaller. Note above
that after shooting ahead last summer, the SSEC fell behind by roughly the
same distance before it started rallying with the SPX again in the latter
third of last year. This is classic pendulum-like mean-reversion behavior, an
extreme on one side of an average being followed by a nearly-equal extreme on
the other side.
By November 2009,
the SSEC had nearly caught up to the SPX in performance terms since March
2009. It really started diverging late that month, which was exactly when the
US dollar bounced into a bear
rally after a long bear-market downleg. It was this healthy and expected
dollar rally that initially started driving the euro lower, and it was the
weakening euro that ignited the popular Europe-implosion fears centered
around an extremely irrational euro-to-zero mindset. A weaker euro has
actually weighed on China since late last year, something I hadn't
realized before digesting this chart.
By this week, the
divergence between the SSEC and SPX performances in their parallel cyclical
bulls had ballooned to massive proportions. The SSEC fell to 15-month
lows, nearly back to where it started in March 2009. To go from up 64%
in early August 2009 to up less than 12% in early July 2010 effectively wiped
out China's entire cyclical bull! This is insane, in the US markets cyclical
bulls never give back that much regardless of sentiment.
And if all this
was caused by the euro panic,
which was in turn driven by the SPX
correction igniting fear-driven dollar buying, then all this sentiment
has already started to reverse. As the SPX recovers and its young cyclical
bull continues, the dollar will resume drifting lower again on its terrible
fundamentals and the euro will recover dramatically. A stronger euro makes Chinese
goods more affordable for Europeans again and ensures Chinese exports to
Europe will remain high. And the Shanghai Comp is off to the races!
Based on the
history of the SSEC's relationship with the SPX, I totally expect the
more-volatile and higher-potential SSEC to regain the performance crown in
this cyclical bull. Obviously to accomplish this, especially as the SPX is
rallying simultaneously, the Chinese stock markets will have to surge
dramatically like they did last summer. And this is certainly probable,
especially given how oversold they've recently become.
And surging
Chinese stock markets will lead the world's commodities traders to assume the
Chinese economy is recovering faster, thus commodities demand should
accelerate. This major shift in sentiment should drive huge commodities and
commodities-stock buying. Given how oversold commodities stocks recently
became partially due to the China-correction sentiment, their potential for
gains is vast over the next 6 to 12 months.
At Zeal we've
been aggressively adding all kinds of commodities-stock positions recently as
the SPX and SSEC corrected. The bargains have been amazing, with prices so
low in many elite stocks that traders couldn't even have imagined them back
in March or April. But with the stock markets starting to rally impressively
this week, this opportunity is already fading. Almost all of the stocks we've
recently recommended near incredible lows have the potential to easily double
or triple within the next year!
If you've been
sitting on the sidelines worrying about the stock-market weakness, don't
delay in getting deployed. Major corrections of this magnitude are rare
within cyclical bulls, so the awesome buying op we've been presented with
won't repeat anytime soon. To better understand where the markets are going
and why, to learn about great investment and speculation opportunities as
they arise, and to see exactly which stocks I am trading and when, subscribe
today to our acclaimed monthly or weekly
newsletters!
The bottom line
is the Chinese stock-market action really affects commodities sentiment
globally. Just like here in the US with the SPX, investors interpret a strong
Shanghai Comp as an indication of a strengthening Chinese economy and hence
expanding commodities demand. So they rush to buy commodities and commodities
stocks to capitalize on this bullish shift in fundamental expectations.
And thanks to the
recent impact of Europe's woes on China's stock markets, the Shanghai Comp is
radically oversold today. To mean-revert back to performance norms with the
US stock markets, the SSEC is going to have to rocket higher. This bodes
extremely well for commodities-stock sentiment, and will likely drive a
frenzy of commodities-stock buying in the coming months. The potential is
amazing!
Adam Hamilton,
CPA
Zealllc.com
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2006 Zeal Research (www.ZealLLC.com)
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