The short-term divergence of the Shanghai Composite and S&P500 is creeping onto our radar as Chinese stocks experienced the largest weekly loss in more than two months. Fears of credit tightening have pushed the index to the lower end of a two month trading range. The August closing low of 2572 is key support and a break there could take the index down another 7 percent to 2373.
Meanwhile, the S&P 500 is challenging the upper bound of a four month trading range. The index touched 1131.47 on Friday, topping the June 21 high of 1131.23, and the August 9 high of 1129.24. The index is very close, but has yet to top the August 9 closing high of 1127.79.
This week will be an interesting test for both markets. Watch the China/U.S. divergence as the 10-day correlation is at an extreme -.65, a level where the two markets tend to recouple and begin to move together.
In March, the 10-day correlation hit -.62 in the midst of the S&P’s strong rally to its April 23 closing high of 1217.28. After floundering for several days, the Shanghai Composite began a modest rally to close at the April 14 high of 3166.18, before a sharp sell-off.
In January, the 10-day correlation hit an extreme -.708, on January 18, just one day before the 1150 S&P500 peak and subsequent sharp 100 point two week sell-off . The most recent highest close of the year on Shanghai Composite was made on January 19 just one day after the extreme 10-day correlation reading.
Though there is a lot of noise in a 10-day correlation, it does appear, however, extreme readings do signal a moderate to significant move as the indices recouple. Keep it on your radar!