New Year's Test: Shanghai Composite Vs. S&P 500

The Chinese economy is supposed to be much stronger than America’s. GDP growth in the People’s Republic hovers near 10%. The GDP improvement in the US this year may be no better than 2.5%.

The economic growth contrast between the two countries is not likely to be much different next year. That makes it a challenge to analyse why the Shanghai Composite is down 15% this year while the S&P 500 is up better than 10%. There must be some broad wisdom among traders who believe that public companies are generally better off when that they are based in the US than they are on the mainland.

The profits of the S&P 500 firms are expected to grow fairly well next year. Many of these corporations have cut costs and better sales should improve margins. But, China’s economic growth should help major companies in its market do extremely well.

Investors may believe that company profits in China will be eroded by inflation. These enterprises may not be able to pass their cost of goods to trade partners. The consumers in the EU region and US will probably not have the capacity to pay a great deal more for products made in the People’s Republic.

Another explanation for the lackluster performance of the Shanghai Composite is that as the Chinese central bank tightens the money supply, the GDP growth rate will decelerate much more than expected. The choice between uncontrolled inflation and rapid economic growth will be difficult, and it may not be in the hands of the Chinese government. Market forces may overwhelm its control of prices.

The Shanghai Composite could turn out to be a canary in the coal mine. China faces economic challenges in 2011, and many of them could not be anticipated just a few months ago.

Douglas A. McIntyre