We like to look at Hong Kong’s Hang Seng Index as the “indicator species” for global risk appetite. Over our 25 years of trading, we have noticed that the Hang Seng tends to lead most risk markets and is usually first on and first off. This is reflected in the chart below where the Hang Seng has led the S&P500 during the past year, though was a more reliable leading indicator of “risk off.” Note, the Hang Seng led the correction in January and April by several days.
The Hang Seng and Gold ETF chart is quite stunning to us, not just how closely they have tracked on a directional basis over the past three months, but the fact they trade in different time zones. Even though the gold market basically trades around the clock, the Hang Seng index closes at 3:00 AM New York time, more six hours before the GLD opens for trading.
This confirms our suspicion the index is a leading indicator for global risk appetite and why we are watching the current divergence between the Hang Seng and S&P500 very closely. The Hang Seng is threatening to break the neckline of a head and shoulders pattern it has been carving out since early October. Meanwhile, the S&P500 is breaking to new highs.
The Hang Seng is reacting to China’s attempt to arrest the massive credit expansion that is now pushing up inflation. The tightening is causing market tremors and worries of a hard landing in the property market, which we have written about.
Many analysts are making the case that the U.S. will be the best equity market in 2011 as Europe struggles with a debt and existential crisis and Asia and the emerging markets are in the early innings of a tightening cycle. Improving economic fundamentals in the U.S. will thus outweigh these negative factors, allowing America’s stock market to decouple from the rest of the world, which could be cause of the current divergence.
The argument makes sense to us and we tend to lean in that direction, though we are not certain and will always remain flexible as not to be broke(n). But, if the Hang Seng breaks hard here, as a matter of principle based on history, we will reduce risk and reassess our 2011 outlook. Keep it on your radar!