CHINESE BANK TIGHTENING WORRIES GLOBAL STOCKS AND COMMODITIES -- ANOTHER WORRY IS THAT CHINESE STOCKS ARE NO LONGER LEADING THE REST OF THE WORLD HIGHER

KEEPING AN EYE ON CHINA ... The announcement that China is tightening monetary policy by raising bank reserve requirements has caused nervous profit-taking in global stock and commodity markets. Since China has been the engine driving the global economic recovery (not to mention rising stock and commodity prices), any hint that Chinese authorities want to slow things down sends a chill through global bulls. There's another reason to keep a close eye on China. That's because its stock market is no longer leading the world higher. In fact, it may be doing just the opposite. Chart 1 shows China iShares (FXI) falling below their 50-day moving average today on rising volume. [The two biggest volume days in the new year have been to the downside]. More important is the fact that its January peak is well below its November peak. That comes at a time when most global stock markets (including the U.S.) have recorded new recovery highs. That creates a potential "negative divergence" between Chinese and global stocks. That may be important because the Chinese market has been a leader of global stocks over the last three years in both directions.

Chart 1

CHINA AS A WORLD LEADER... Chart 2 compares China iShares (red line) to the Dow Jones World Stock Index (blue line) over the past three years. I'm using a log scale for comparison purposes since it shows percentage changes. The chart shows China leading the rest of the world lower from October 2007 to October 2008. China shares bottomed at that point which was five months before the rest of the world turned up (see arrows). From the March 2009 bottom, China gained 78% versus a 65% gain for the rest of the world. Unfortunately, China is no longer leading the world higher. Since the end of July (and even more so since mid-November), China has become a global laggard.

Chart 2

Chart 3

CHINA'S RELATIVE PERFORMANCE WEAKENS... China 3 shows the relationship even better by plotting a relative strength ratio of China iShares (FXI) divided by the DJW World Index (DJW). The ratio shows China leading the rest of the world lower from October 2007 to October 2008 and higher since then. The rising ratio during the first quarter of 2009 (green trendine) provided a "bullish divergence" between China and the rest of the world. Unfortunately, that's no longer the case. Chart 3 shows the FXI/DJW ratio peaking at the end of July and forming a "lower low" in November (red trendline). Since the end of July, global stocks rose 18% versus less than 2% for China. Since mid-November, global stocks have rallied 4% while China has lost -5%. In other words, China shows "bearish divergence" from the rest of the world. If its role as a global leaders is still in effect, that relative weakness by Chinese stocks may be a negative warning worth paying attention to. Especially if Chinese central bankers decide to start taking the punch bowl away.