Common movements of Chinese and global stock markets: Two insights

China’s emergence as a worldwide economy on the world stage is maybe the best economic development of the last 30 years. Over the past few a long time, China’s industry has modernized, a lot of its technology firms have made their debut on Chinese stock exchanges via initial public offerings (IPOs), and the country’s markets and stock exchanges have opened as much as some extent to foreign investors.

China is becoming increasingly integrated into the worldwide economy. But despite this development, China’s stock markets sometimes still develop idiosyncratically in comparison with other stock exchanges on the planet. Due to restrictions on short selling and other aspects, China’s stock markets have sometimes been vulnerable to increased volatility. There were notable bubbles and collapses on the Shanghai Composite Index in 2007 and 2015.

How, then, have the collective movements of Chinese stock markets evolved over the past 25 years because the country has gained a stronger presence in global markets?

To answer this query, we checked out how correlations have evolved between China’s two major stock exchanges – the Shanghai Composite Index and the Hang Seng – and their counterparts around the globe. We then divided the time periods into three categories – 1997 to 2004, 2005 to 2014 and 2015 to present – to see what form of pattern emerged over time.

We have isolated two essential findings.

First, the correlation between the Shanghai Composite and the S&P 500 has increased significantly over the past quarter century. Between 1997 and 2004, the correlation was 0.08. In our most up-to-date sample, the correlation coefficient increased to 0.47, representing the biggest shift in co-movement during our entire sample period.

Correlations: Shanghai Composite to S&P 500

The huge increase within the Shanghai Composite’s parallel movements isn’t limited to the S&P 500. The correlation coefficients of virtually all stock exchanges around the globe, even the XLK US tech index, have all jumped with the Shanghai Composite between 1997 and today. The only exception? Russia’s MOEX.

The query is why. What explains the increasing correlations?

Correlations: Shanghai Composite and Hang Seng vs. global exchanges
August 1997 to December 2004

January 2005 to December 2014

In our view, it’s on account of two aspects or a mixture of them: the opening of Chinese markets to the remaining of the world and the growing presence of banking and technology stocks within the Shanghai Composite.

All time correlations: Shanghai Composite, Hang Seng and Global Indices

Our second key finding is that the Shanghai Composite’s increasing correlation with world markets isn’t reflected within the Hang Seng. Global indices have historically had a stronger correlation with the Hang Seng, however the co-movement between it and other exchanges has not increased all that much over the past quarter century. The S&P 500 had a correlation coefficient of 0.59 with the Hang Seng from 1997 to 2004. This has modified little. Since 2015, it has been 0.60.

All in all, China’s emergence on the world stage has shifted correlations amongst its equity markets. The Shanghai Composite is now rather more correlated with global markets, with its correlation coefficient having nearly doubled in only 10 years.

However, no similar trend might be observed on the Hang Seng. Its correlation with most stock exchanges worldwide has hardly modified over the past 25 years.

Whether these correlation trends will proceed in an era of accelerating geopolitical competition will remain to be seen in the approaching months and years.

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Photo credit: ©Getty Images/Johannes Mann