I have of course written about this before since we read so much about China as the new #1 (economy) spreading its economic influence throughout the world. There are many problems with this oversimplified analysis including the problem that they don’t have proper cap weighted stock index contracts that reflect GDP or tradable goods or even aggregate national profitability.
Here we go anyway:
As with any equity market comparison, we will see a strong correlation to the S&P. Huge magnitude divergences can look like signals but they rarely work. If (say) China is way outperforming then we tend to think of that as a source of stability – it’s not. Major moves tend to fit in with the S&P but there are no reliable leads or lags that are exploitable.
We can see here that a rallying Chinese market is associated with a rising S&P but the proof of the irrelevance of this market is its impact when it falls. If you sympathetically shorted the ES contract after a decline (when the Chinese market is below its MA”s, you would lose money rather consistently. (Total history here is just the last 4 years but going back further doesn’t improve results).
What about the Euro? Can we argue that a weakening China is consistent with a weaker Euro since the Euro will be happy about free trade with the US just like the China FTSE 25 would be? Flight to the $ would match up with a flight to the S&P (out of Chinese equities).
We have a skew problem Since the Euro went down during the sample period so it looks like the trade only works from the short side but the losses from buying were far better than what we would have had with no filter at all. This single filter won’t suffice so let’s add one:
Adding the Euro Fuel Gauge filter makes a huge difference and I wasn’t that picky. I just wanted to split the timing of trades into 2 states = > 50 and < 50 The resulting returns are serious enough to be remembered:
- Buy if the China index is up (10 day MA) and the Fuel Gauge >50
- Short if the China index is down and the Fuel Gauge is <50
The aggregate (frictionless) daily returns are below:
The scenario we have/need for a declining Euro is intact and working.
I welcome all your comments and questions.