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]

Should You Go Long at Volatility Extremes? A Look at the Nikkei 225

Japan’s Nikkei 225 stock index is the primary index used to track the Tokyo Stock Exchange. It was also the index that captured the fall of the Japanese stock market from 38,959 on the last day of 1989 to 7,603 in April 2003, a drop of 81% over the course of more than 13 years.

The Nikkei, therefore, provides an opportunity to test the idea of whether it is profitable to initiate new long positions in times of extreme volatility, even in prolonged bear markets.

In order to test this hypothesis, I reviewed the data for the Nikkei 225 from 1984 to the present and singled out the ten most volatile days during this period, using various volatility measures such as historical volatility and average true range. The result, which includes a number of overlapping days and clusters of similar volatility extremes, is displayed graphically in the chart below, courtesy of Stockcharts.com. In the chart, the seven instances with the highest volatility levels are highlighted by green arrows. Note that in each case a rally of at least two months followed these volatility extremes. In the one bull market example, the new bullish trend lasted for two years; in all the other bear market examples, the new bullish trend lasted from two months to 1 ½ years.

For the record, the action in the last two weeks in the Nikkei would make the current environment the most volatile of all instances, just as is the case for the S&P 500 at the moment.

While all bear markets are not created equally, Japan's "lost decade" does bear some resemblance to the problems in the U.S. Looking at the historical record with a global perspective, it is tempting to conclude that the current situation ripe for another volatility bounce of at least two months.

[source: StockCharts]