The U.S – China divergence…Which market is right

The U.S. markets have been marching up and hit a 3.5-year high with the S&P 500 touching 1425 this month. On the other hand, the Shanghai Composite is at a 3.5 year low, around 2050. This index was at 3400 at the end of 2009. This has to be one of the strangest phenomena in world markets today. On the one hand, China was being touted as the savior of the global economy for the last 4 years since the financial crisis of 2008, and the growth engine of the world. On the other hand, its markets are absolutely in the dump. Take a look at this scary chart comparison of the Shanghai Composite and the SPX (S&P 500 index), by Michael Paulenoff.

In a globally connected world, how can the world’s #1 economy and the #2 economy be so divergent ? It just does not make sense. Recent news from China has been terrible. We highlighted the growing inventory problem as reported by the NY Times here. Real estate is obviously a bubble in China, and the government is trying its best to deflate it smoothly. Growth has slowed, but its still a respectable 6 to 7%. But Chinese market participants are obviously not buying this “soft landing” theory. Chinese government numbers are always suspect, so my guess is the big players in the Chinese markets have massively discounted the official numbers. The picture must really be scary.

So the question is – which market is lying ? Because one out of the two has to be a headfake. This disconnect cannot go on. The U.S. markets are today, like a hopeless drug addict, waiting for anything that Ben Bernanke would say that might provide the next fix. Summer is over, its back to school, and its time to be vigilant in the US markets. If you have “long” stock portfolios, its time to protect and hedge. The VIX is also at a 3 year low, indicating complacency. Great time to buy some Put options for protection and profits.

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