Stocks

The relationship of currencies to stock markets is squirrely. Sometimes, but not often, a currency will move in line with its stock market. Japan is the big exception — the Nikkei rises when the yen falls, since exporters benefit from a lower currency level.

On the whole, currencies move inversely to stock prices, but it’s not a consistent relationship. Stock traders seem to live in their own universe and currency traders live in theirs. For one thing, stocks tend to rally when interest rates are nudged down but currencies tend to do the opposite — they fall when rates are nudged down and rise when the yield differential rises in their favor.

In addition, the percentage of foreign participation in most stock markets tends to be fairly small (less than 20 percent), again with the exception of Japan, where it’s a little more than 40 percent. This is, however, in the process of changing with the 1999 advent of the euro and U.S. enthusiasm for diversification (a lesson now learned and not to be forgotten). Besides, as we have seen from 1929 to today, stock market sentiment seems to leak from one market to another, and especially in the case of a sharp decline (Figure 3). Nobody thinks if the U.S. indices crashed outright (a 20-percent-plus move down) European bourses would be a safe haven. No, European markets and most, if not all, others would follow the U.S. markets down, regardless of what currencies are doing.

The one country where the currency- stock market mismatch is the most glaring is China. The Shanghai index is up six-fold while the currency is barely up 10 percent (Figure 4). Experts such as Mr. Greenspan say we know we have a bubble only after it breaks, but this chart looks uncannily like the Nasdaq chart (Figure 5). It may take years for the Shanghai bubble to burst, or it could come next week. Or maybe it’s not a bubble and won’t come at all. Nobody knows.
However, we can be fairly sure if the Shanghai undergoes a “correction” like the Nasdaq did in 2000-2002, China will face domestic difficulties, including a potential drop in overall activity that would reduce demand for commodities, including oil.