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WHERE IS THE pulse of the 2012 world economy located? Europe has no pulse and looks to have a high potential to move into a full cardiac arrest. The pulse in the US is erratic, but weakening. Although many have pointed to the 1% loss in the Standard & Poor’s 500 Index in 2011, the real shock is the very meagre 12% rise in the S&P 500 from 2010 to end-2011. This is not a bullish story. It is two years of virtual stagnation despite the current index rally. The pulse in China appears to be losing some strength, although it remains stronger than either Europe or the US. The longer-term prognosis is for some weakness going into 2012.
Locating the pulse is one task. Measuring it is another. The traditional measures of GDP and GDP growth are inexact tools and backward- looking. They tell us what happened in the past, and are subject to frequent revisions after their release. Measuring the economic pulse is most effectively done using the index behaviour, because markets tend to be forward-looking.
When we compare the major indexes — the S&P 500, DAX and FTSE and Shanghai Index — we observe some interesting longterm relationships. These are not lockstep relationships, but markets do move in a loose synchronicity.
The end of 2007 saw a fundamental change in these index relationships. The Shanghai Index took the behavioural lead and has yet to relinquish it. As the Shanghai market collapsed in late October 2007, it led other markets by eight to 12 weeks.
The Shanghai Index led the collapse in 2008, showing that the head-and-shoulders pattern targets would be achieved. The Dow Jones Industrial Average collapse followed a few months after the initial Shanghai Index retreat.
The recovery in early 2009 was led by the Shanghai Index, with the beginning of a market rebound developing in November 2008. It was March 2010 before the Dow and the European markets followed the same rebound path.
Again, it was the Shanghai Index that peaked in August 2009 and began a slow sideways movement that characterised all markets in 2010. The Dow and European markets followed this broad sideways consolidation.
We are not saying other world markets are influenced by or slave to the behaviour of the Shanghai market. We are suggesting that the behaviour of the Shanghai market, for whatever reason, has been leading the behaviour of Western markets since late 2007. This is a very significant change in inter-market relationships.
This new relationship makes the divergence in behaviour in 2011 particularly interesting. European and US markets have struggled to add value in 2011. The Shanghai market, in contrast, developed a steady and relatively smooth selloff that took the index towards a retest of the 2008 lows.
The DAX and the FTSE showed the same behaviour, but with less smoothness. The corrections in these markets have been much faster and more violent, and they are well on the way to testing 2008 lows.
The US market stumbled in 2H2011, with the Dow plunging towards 10,600. It requires only another slump of the same magnitude below this support level to send the Dow on its way to test the 2008 consolidation areas. The lack of weakness in the Dow and S&P are in marked contrast to the growing weakness in Europe and the established weakness in China. Given the relationship between the Shanghai Index and other global indexes, there is a strong probability the US market will feel the pressure and follow the lead.
This is why it is particularly important to follow the behaviour of the Shanghai Index and watch for evidence of consolidation at or near the 2008 lows. It is the nature of this consolidation and any rebound that develops that will provide the leading indication of how European and US markets may develop in 2012.
The Shanghai Index had only a few days of trading in the last two weeks and there is not any change in the market condition. The index is falling towards its long-term historical support near 2,000. This is the upper edge of a trading band that was created in December 2008. The lower edge of the trading band is near 1,700. The consolidation trading band should create a firm foundation for a market rebound and recovery. This is because the consolidation band was a successful support area in 2008, and the rebound from this support level also developed into a successful new uptrend.
