Germany and China Faring Relatively Well in Downturn

With the SPX perched precariously above its November low and pundits monitoring the vital signs around the clock, coverage of the stock markets in the U.S. has once again taken on a very Americentric tone. For the most part, focusing on the U.S. financial system and the U.S. economy makes sense. One of the many lessons to come out of the current financial crisis, however, is the end of the decoupling myth. In fact, we are all butterflies flapping our wings on a global stage now.

As always, some countries are faring better than others. The chart of the Nikkei 225 looks sufficiently like that of the SPX that I elected to omit it from the graphic below. Instead, I have chosen to compare the stock market indices of the world’s third and fourth largest economies, China (FXT, the index that forms the basis of the popular ETF, FXI) and Germany (DAX), in the context of the S&P 500 and the Dow Jones World Stock Index (DJW).

Note that relative to the October/November lows, China has shown a distinct pattern of making higher lows – in sharp contrast to U.S. and global indices. Germany has also shown considerable resiliency. Even though the DAX is now trading below its November low, Germany stocks have outperformed their global counterparts.

Scrolling back to 2003, I find it interesting that both China and Germany still are well above their 2003 lows, while the Dow Jones World Stock Index is now only about 5% above the lows from that bear market.

So while most investors are currently focusing their attention on the Dow Jones Industrial Average, the S&P 500, the NASDAQ indices and the Russell 2000, support levels and trends in key international indices may hold equally important clues about global buying and selling patterns – and the possibility of finding a bottom.

[source: StockCharts]

Introducing the VDAX

So here I am patting myself on the back about how Dali’s “The Persistence of Memory” is the perfect accompaniment to my nearly finished post on ever shrinking VIX numbers and the warping of our collective sense of time decay…when I decide to visit one of my favorite options blogs. I pause for a second, then do a double take. Oops, that must be my draft post I pulled up by mistake. No, it turns out I am having a surrealist moment of my own. Dali’s melting clocks appeared on the other blog just minutes before they were scheduled to appear on mine.

It felt almost like the CFO of my largest long position had just resigned abruptly, so I have decided to go in another direction today. Make that another continent…

So, today I am introducing the VDAX! Actually, like the VIX and the old VXO, the Deutsche Börse has a new VDAX (aka VDAX-NEW) and an old VDAX. The biggest distinction between the two is that VDAX-NEW is calculated from the implied volatility in the DAX (German counterpart to the DJIA) options looking out 30 days while the original VDAX looks ahead 45 days.

We will discuss the VDAX and other international volatility indices in greater depth at a later date, but for today I want to pose and address two questions:

• What is the correlation between the VIX and the VDAX?
• To what extent does one volatility index lead or lag the other?

In order to answer these questions, I have relied on data for the original VDAX only because I have a better data set. The VDAX and the VDAX-NEW are very highly correlated; in the two graphs below I used data for the original VDAX:

Note the strong correlation between the weekly VDAX and the weekly VIX. In the second chart, the red dotted line and solid ‘best fit’ line for that data series represent the difference between the VDAX and the VIX as a percentage of the VDAX. This difference between the VDAX and the VIX shows that at least over the past year or so, volatility has been dissipating in US markets faster than in the German markets.

As is the case for most comparisons of the US and international markets, it should come as no surprise that the US markets tend to take the lead in volatility moves, with foreign markets usually reacting to changes in the US. Writing in 2003, Sofiane Aboura concludes in International Transmission of Volatility: A Study on the Volatility Indexes VX1, VDAX and VIX that “the information flow contained in the VIX is globally transferred the same day to the VX1 [derived from the CAC 40] while it is diffused the two first days to the German market through the VDAX. We note again the contemporaneous relationships between the US and the French implied volatility indexes.”

So, from the same continent that brought you Salvador Dali, we have the VDAX – and we also have a date with Dali to discuss volatility in the not too distant future. In the meantime, I will leave you with one of his quotes:

“Have no fear of perfection - you'll never reach it.” ~ Salvador Dali