Bespoke Investment Group

Dubai Default Risk

As shown in the Bloomberg snapshot of Dubai's historical sovereign debt credit default swap price, the recent spike up to 600 bps or so isn't even near the level of 1,000 bps seen earlier this year.  Had Dubai's default risk spike earlier this year been an isolated event like it is this time around, it would have made news back then.  At the time, however, default risk was spiking for the majority of developed nations as well, so Dubai was the least of our problems.  Now that global markets have stabilized and exited crisis mode, an isolated event in Dubai where default risk doesn't even spike to its 2009 highs has caused a global market selloff.

  

Below we highlight current credit default swap prices and the year-to-date change for the sovereign debt of 39 countries.  As shown, default risk has declined for every country except Japan in 2009, including Dubai.

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China Has Worst Day Since August

After an impressive rally off the Summer lows, China's Shanghai Composite index has recently risen to within 3.5% of its 2009 highs.  However, after last night's decline, the index has dug itself into a bit of a deeper hole.  Last night, China's benchmark index declined over 3% for its worst day since August 31st.  The decline was in reaction to growing concerns that the nation's largest banks will be forced to raise capital due to the unprecedented amount of loans they have extended in 2009.  With China down over 3%, the baltic dry index down for the third straight day, and Russia cutting interest rates to record low levels, the early tone for emerging markets is looking a little shaky.

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Japan in the Tank

While equity markets around the world have been charging to new 52-week highs over the past six months, Japan's Nikkei-225 has been stumbling.  As shown below, the Nikkei has been in a downtrend since early August, and it just broke to new short-term lows in recent days.  The S&P 500 is up 16.57% over the last six months while the Nikkei is up just 2.79%.

 

Checkup on China and the Baltic Dry

China's Shanghai Composite stumbled significantly during the late summer, but it has come back nicely with a gain of 24.5% off of its lows at the end of September.  While its rally has been impressive, Shanghai has yet to take out its 2009 highs made in early August.  At the same time, the cost to ship goods as measured by the Baltic Dry Index has increased 115% since its lows in September and has made a new 2009 high.  Traders like to relate the Baltic Dry Index to how things are going in China, so with the Baltic Dry charging to new highs, will the Shanghai Composite follow?

2009 Country Stock Market Performance

Below we highlight the year-to-date percentage change (local currency) for the major equity indices of 82 countries.  So far this year, 71 of the 82 countries are in positive territory, and the average change of all countries is 33.27%.  With a gain of 20.76%, the S&P 500 is 13 percentage points below the average, yet it's the second best G-7 performer behind Canada so far in 2009.

The BRIC countries (Brazil, Russia, India, China) have been standouts this year.  Russia is up the most out of all countries with a gain of 126.71%.  Brazil, China, and India are all up more than 70%.  Along with Russia, the Ukraine, Argentina, and Peru are up more than 100% year to date.

Eleven countries are down so far in 2009.  Ghana is down the most at -48.26%, followed by Puerto Rico (-40.56%), Bermuda (-38.36%), and Costa Rica (-35.37%).

Chinese ADRs Outperforming Stocks in China

In a late July report to Bespoke Premium clients, we noted that even though the sizzling stock market in China was generally closed to outside investors, US investors still had plenty of (and in some cases superior) options to invest in Chinese stocks through the vast number of Chinese ADRs trading on US exchanges.  There are currently over 125 Chinese ADRs that trade on US exchanges, and of those, 58 have market caps of more than $300 million. 

Now that the Chinese equity market has stabilized and is back on the upswing, we updated our chart comparing the performance of the Chinese stocks listed locally in China and their US listed peers (ADRs).  While locally listed Chinese stocks are still well below their peaks from August, our basket of US listed ADRs remains in a well-defined uptrend and has broken out to new highs for the year.

 
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Country Default Risk

Below is a table highlighting current credit default swap (CDS) prices for the sovereign debt of 38 countries.  The CDS prices represent the cost per year to insure $10,000 of debt for 5 years.  The US CDS price is quoted in Euros.  The list is sorted by year-to-date change, and as shown, default risk in Russia and Australia is down the most in 2009 at -77%.  US default risk is down 68.1%, which is the most of any G-7 country.  Japan is the only country that has seen default risk actually rise in 2009, but it also had the lowest CDS price of any country at the start of the year.  Overall, while CDS prices are down sharply in 2009, they remain well above where they were at the start of 2008, so there's still plenty of recovery work to do. 

 

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Russia Soaring

For whatever reason, we've been hearing calls lately for Russia to lose its BRIC status because it's not in the same league as Brazil, India, or China.  While some might take offense to this, other investors in Russia probably don't care as long as its stock market continues to perform like it has in recent months.  As shown below, Russia's RTSI index has soared to new 2009 highs over the past few days, and it is now up 117% year to date.  For comparison's sake, India's Sensex is up 72.5% YTD, Brazil's IBOV is up 70%, and China's Shanghai Composite is up 60%.

 

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Brazil Catches A Bid

While Chicagoans suffered a blow at 11:30 AM ET this morning when the IOC voted the city out of the running for the 2016 Summer Olympics, investors in Brazil saw a nice jump-up in stock prices on the news (see chart below).  The Bovespa continues to rally intraday as the final vote between Madrid and Rio nears, and Brazil is now heavily favored to win.  If Brazil does win, there will most likely be quite a few business articles published in the coming days telling investors to buy the Brazil ETF -- EWZ.

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Chinese ADRs Still Holding Near Their Highs For the Year

While the Shanghai Composite looks to be on the path to new short-term lows, Chinese ADRs continue to hold up well.  In the chart below, we compare the YTD performance of the Shanghai Composite to our basket of Chinese ADRs with market caps of more than $250 million.  The Shanghai Composite is currently up 51.28% in 2009, which is down considerably from its highs in August.  Chinese ADRs, on the other hand, are still up 95.9%, which is right near their highs for the year.

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International Equity Market Snapshot

Below we provide our unique trading range charts for 21 major country indices.  For each index, the light blue shading represents between one standard deviation above and below the 50-day moving average.  When the price is within this trading range, it is considered to be in "neutral" territory.  The red zone represents between one and two standard deviations above the index's 50-day moving average.  Moves into or above the red zone are considered "overbought."  Moves into the green zone (more than one standard deviation below the 50-DMA) are considered "oversold."

With the exception of a few Asian countries, most indices shown below are trading into overbought territory.  China's Shanghai Composite is the only index trading below its 50-day moving average.  Australia, Brazil, South Korea, Taiwan, the UK, and the US look to be the most overbought of the bunch.  After trading in perpetual downtrends for nearly all of 2008 and the first few months of 2009, most countries have now been trading in solid uptrends for five months now, with only a brief pullback here and there.  Brazil, China, Hong Kong, India, Malaysia, Mexico, Singapore, Sweden, Spain, South Korea, and Taiwan have all taken out their 52-week highs in recent months, while the rest still have a bit further to go.

Baltic Dry Remains Flat as Markets Continue to Rally

Even as China has recovered significantly from its correction and US markets charge higher, the Baltic Dry Index remains in a downtrend.  As shown in the first chart below, the Baltic Dry peaked at the start of June and has headed steadily lower since then.  China's Shanghai Composite peaked about a month later, but it has rallied nicely since the start of September.  The Baltic Dry led the fall in China during the summer, so is it now suggesting that China's recent bounce is a pump fake, or is it just lagging this time around?

Country Returns Since The Lehman Collapse

The S&P 500 is still 20.34% below its level just before the Lehman collapse, and 49 of the 82 countries shown below have done better.  Also, 28% (23) of the countries are up since Lehman.  As shown, China is up the most since September 12th with a gain of 30.55%, followed by Venezuela (28.35%), Indonesia (26.71%), Turkey (23.57%), Vietnam (15.06%), and Tunisia (12.04%).  Three of the four BRIC countries are up, with Russia the only one down at -21.51%. 

The US ranks 2nd to last in terms of performance for the G7 countries.  Even though a number of market indicators are back to their pre-Lehman levels, the market itself here in the US still has a lot of work to do.  If you think we're at least headed back to September 12th levels, you're expecting a further gain of 25% for stocks.

 

US Lags in 2009

While the Nasdaq is up 28.52% year to date, the S&P 500 and the Dow are up 13.4% and 8.51%, respectively.  This performance ranks poorly versus other countries when measured in local currencies, but it is even worse when we look at country returns in dollar terms because of the greenback's decline this year.  In dollar terms, the S&P 500 ranks third to last and the Dow ranks dead last.  While it's been a good year compared to 2008 so far, it has been even better outside of the US.

 

China ADRs: Even Better Than the Real Thing

Earlier today we noted how Chinese ADRs have been steadily outperforming their mainland peers on a year to date basis. Following the rout in mainland shares overnight, the trend of ADR outperformance appears to be continuing.  Even though the Shanghai Composite was down 6.74% overnight, our basket of Chinese ADRs was only down half that with a relatively modest loss of 3.39%.  With all the talk of how the Chinese stock market was the place to be earlier in the year, the real action was right here in the US with Chinese ADRs.  First, they went up more than their local mainland counterparts, and now they have held up better in the downturn.

China Says Good Riddance to August

With a decline of nearly 7% today, China's Shanghai Composite closed down 21.8% for the month and is now down 29.5% from its recent rally highs.  August was also the first month this year where the Shanghai Composite finished lower.  While Chinese stocks have been weak this month, ADRs of Chinese companies listed in the US have held up considerably better.  Later today, we'll update our basket of Chinese ADRs to see how they react to last night's decline in the mainland.

 

 

Bear Season in China

For the fourth time in six days, China's Shanghai Composite finished down more than 2.5%.  On an intraday basis, the index is down 20.6% from its high just over two weeks ago.  On a closing basis, the Shanghai Composite is down 19.9%, which is dangerously close to the 20% threshold for a bear market.

 

Chinese ADRs Still Outperforming Chinese Stocks

In a late July report to Bespoke Premium clients, we noted that even though the sizzling stock market in China was generally closed to outside investors, US investors still had plenty of (and in some cases superior) options to invest in Chinese stocks through the vast number of Chinese ADRs trading on US exchanges.  There are currently over 125 Chinese ADRs that trade on US exchanges, and of those, 58 have market caps of more than $300 million.  The most impressive aspect of these ADRs was that as of late July, a basket of the 58 largest Chinese ADRs was actually outperforming the Chinese stock market (Shanghai Composite). 

Now that the Chinese stock market is down over 17% from its high, we updated our performance of Chinese ADRs to see how they have been holding up.  The results have been surprisingly strong.  As shown in the chart below, Chinese ADRs are still up nearly 80% YTD, while the Shanghai Composite is up just under 58%.  Since the August 4th high, Chinese ADRs are down 8.9% compared to a decline of 17.3% for the Shanghai Composite.  Based on these results, Chinese ADRs either have further to fall, or else the sell-off in Chinese stocks is overdone. 

 

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Shanghai: World Leader to World Laggard

What a difference a few days makes.  It wasn't long ago that China's Shanghai Composite was sporting triple-digit gains for the year, and investors were wondering how high it would go.  But today the main question is when will the selling stop?  In a span of only ten days, the Shanghai Composite has lost 17.5% of its value, bringing the index dangerously close to the technical threshold for a bear market (-20%).  Given that many were relying on China to help lead us out of the economic recession, the action in China's stock market is helping US equities start the week off on a notably bad note.

 

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Chinese Stocks Break Below 50-DMA

Yesterday we noted that China's benchmark stock index (Shanghai Composite) managed to put in a modest rally after testing its 50-day moving average (DMA).  The support at the 50-DMA didn't last long though.  Last night the Shanghai Composite dropped nearly 3% for its first close below the 50-DMA since January.  After nearly doubling YTD, the index is now down by over 12% from its peak on August 4th.  Given that China is supposed to be the engine of global growth and has been a leader in the global equity rally, it will be interesting to see if other country indices follow suit to the downside.  With the Dow down 150 this morning, we might have our answer already.

 

Sector performance in China paints an interesting picture.  In typical selloffs, sectors that lead the rally see the steepest declines, while laggards in the rally tend to outperform.  In this selloff, however, this trend is much less evident.  The chart below shows the average performance of Chinese stocks by sector during the rally and since the peak on 8/4.  While Energy led the rally and has seen the sharpest decline, in other sectors the relationship has been much less evident.  For example, Utilities and Telecom Services were in the bottom four in terms of performance during the rally, but during the decline they have also been among the weakest sectors with the second and third worst performance.

 

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China Tests and Holds 50-DMA...For Now

After a 10.5% decline from its August 4th peak, the Shanghai Composite index tested and held its 50-day moving average (DMA) overnight with a rally of 0.89%.  It is likely that if the index had failed to hold its moving average, this morning's pre-market setup would have been a lot less positive.  While the bulls here and in China would probably have preferred a more decisive bounce off of the 50-day, they'll take what they can get for now.

  

Shanghai Composite Back Near Recent Highs

Remember the 5% selloff in China's Shanghai Composite index earlier in the week?  Neither does the market.  Following the selloff, markets across the globe declined on concerns that the so-called engine of economic recovery was beginning to falter.  Since then, the index has had two straight days of solid gains and is right near the level it was at before Wednesday's selloff. 

 

Country Returns Since July 10th

The S&P 500 is up 11.24% since July 10th, which is a significant move in such a short period of time.  The recent gains also put the index up nicely at 8.28% year to date.  As shown below, the US has performed well relative to the rest of the world.  Since July 10th, it ranks 22nd out of 82 countries.  Russia is up the most with a gain of 24.23%, followed by Hungary, Poland, Norway, Romania, and Germany.  Middle and Eastern European countries have seen some of the biggest gains in recent weeks.

While China has been the second best performing country (behind Peru) year to date, it is only up 10.32% since July 10th.  This is better than most countries, but it hasn't been the worldwide leader that it was earlier in the year.  Five of the G-7 countries have outperformed China, and all seven G-7 countries are in the top 50% in terms of performance.  This is a sign that developed markets have been holding their own against emerging markets in recent weeks.  Only ten out of 82 countries are down since July 10th, with Slovakia leading the way at -5.67%.

China On Run Of A Lifetime

China's Shanghai Composite is currently up 81%, and as shown in the chart below, down days in recent months have been few and far between.  Even though rest of the BRIC (Brazil, Russia, India, China) countries have posted big gains year to date, China has broken away from the pack.  Overbought has become the new norm for the Chinese equity market, and anyone that has bet on a pullback has gotten absolutely crushed.  Remember, however, that the sharper the increase usually means the sharper the fall, so when a correction does finally come, watch out.

 

Sovereign Debt Risk Declines

Below is a price chart for a credit default swap (CDS) on US debt.  This is basically the cost per year to insure against US default for five years.  In late 2008 and into early 2009, investors were extremely worried about countries defaulting.  Five-year CDS prices (in euros) for US debt rose from about 8 bps to 100 bps, but they have since dropped to about 40 bps.  Along with the drop in US default risk, all but three (Japan, Israel, Ireland) of the 38 countries in the table below have seen default risk decline in 2009.

  

Russia and China are in the top five of countries that have seen default risk decline the most.  Germany and France haven't seen their default risk decline by much, but it also didn't rise nearly as much as other countries during the height of the crisis.  Germany, France, and the US have the lowest default risk in the world.

 

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