Thursday, August 16, 2007

Chinese Stock Market Uncorrelated with World Markets – Is it the new Safe Haven?

First, let’s take a look at the performance of the Shanghai Index compared to the US indexes over the past 6 months.

Despite earlier thoughts that the Chinese market had topped and shortly would implode; the Shanghai Index appears to be driving towards new heights. The robust growth in China’s economy and inflow of cash from new investors is driving the internal stock market. The situation appears to still be a “bubble”; the question being how much more can it inflate.

One interesting note is that the Chinese stock market from a correlation perspective is the least correlated with world-wide markets. On days the Chinese markets go up, the world markets are down… and visa-versa. The lack of correlation to the outside markets makes the Chinese market a potential safe haven as a component in a diversified portfolio. Straight-forward math in Modern Portfolio Theory (MPT) would indicate that people should have some component of their stock portfolio be Chinese indexes from a safety perspective.

The economic policies of the Chinese government isolate their stock markets from much of the outside risk. The implementation of yuan currency range setting, limiting monetary inflows/outflows, and limitations on external investment shield the Chinese stock market from some of the external excesses that are now becoming apparent in the credit liquidity crisis.

This is an interesting situation. The concept that a foreign stock market that many believe is in a bubble could potentially be a safe haven… may rewrite the concept of how risk should be evaluated in the financial markets.