REST OF ASIA SHRUGS OFF CHINESE DROP -- JAPAN HAS BEEN WORLD'S WEAKEST MARKET, BUT MAY START DOING BETTER THAN THE US
CHINESE MARKET IS DUE FOR A PULLBACK... The Chinese market lost another 8.2% today. Chart 1 shows the Shanghai Stock Index threatening to break the 50-day average for the first time in nine months. To say that the Chinese market is over-extended is an understatement. Take a look at what it's done over the last year. The SSEC turned up at the start of 2006 three years after other global markets. It's more than made up for its slow start. Over just the last twelve months, Shanghai has risen 137%. By comparison, India and Brazil gained 44% and 41% respectively. The EAFE Index of developed global markets rose 26% while the S&P 500 gained 19%. Japan was the weakest market with a 16% rise. The fact that the Chinese market had risen so far so fast, and was in need of some correcting, may explain why the rest of Asia and the world's other stock markets shrugged off the Chinese plunge.
Chart 1
Chart 2
THE REST OF ASIA RALLIES ... Most of Asia's other markets actually rallied on the Chinese selloff. That includes the Hong Kong market. Chart 3 shows the MSCI Pacific ex-Japan iShares (EPP) hitting a new record high. Some of the day's strongest foreign ETFs were in South Korea, Singapore, and Australia. Even Japan bounced. Europe took some small losses. The U.S. market took its cue from Asian markets outside of China and rallied as well. How things have changed since February when a drop in Chinese caused a global selloff.
Chart 3
GLOBAL CORRELATIONS ... The business section of the Sunday New York Times ran an excellent article by Paul Lim on how to diversify properly into global markets. The writer makes the point that it's not always a good idea to overweight foreign markets that are highly correlated to the U.S. High correlations means that they could fall if and when the U.S. does. This is especially true of Europe which has the highest correlation to the U.S. Lim argues that American investors might want to overweight Asia because it has the lowest correlation to the U.S. Hong Kong, for example, has only a .55 correlation to the U.S. versus .89 in Germany. India has a relatively low correlation of .43. Not surprisingly, the market with the lowest U.S. correction is Japan (.29). That qualifies Japan as one of the globe's best vehicles for global diversification.
JAPAN IS STARTING TO JUMP ... Just because Japan has been weak isn't a convincing reason to commit funds there. It makes more sense to wait until the Japanese market starts showing some signs of life. Like now. The daily bars in Chart 4 show the Japan iShares (EWJ) closing above its early May peak and a three-month down trendline. The daily MACD lines have turned positive for the first time since late February. There's also some encouragement on relative strength grounds.
Chart 4
EWJ/S&P 500 RATIO IN CHART SUPPORT... Chart 5 is a ratio of Japan iShares (EWJ) divided by the S&P 500. The EWJ has under- performed the S&P since last May. The ratio is starting to bounce from potential chart support at its November low (Chart 5). Chart 6 gives a five-year view of the EWJ/S&P ratio. Japan has done better than the U.S. over those five years. Except for the last year. Notice, however, that the ratio is starting to bounce off a five-year support line that started in 2002. Those two charts suggest that this might be a good time to take a closer look at Japan. That's especially true for those investors who are concerned that all of the other global markets are too closely correlated.
Chart 5
Chart 6
