Great Graphic: The Shanghai Composite and the Nikkei

This Great Graphic was generated on Bloomberg.  It show the performance of the Shanghai Composite (white line) and the Nikkei (yellow line) over the past six months.  The performance has been indexed so as to help capture the relative performance.  

Over the past six months, both indices have risen a little more than 21%.  Year-to-date, though there is a different story.  The Shanghai Composite has risen a little more than 17%, while the Nikkei has gained a little less than 7.5%. 

There seem to be two key drivers of the Shanghai Composite.  First, as the government pushes against shadow banking and wealth management products, it is encourages domestic risk capital to be invested in the equity market.  Second, and more important recently is Shanghai-Hong Kong equity link that will allow Hong Kong equity account to buy stocks that trade in Shanghai, albeit limited to a couple billion dollars a day.  At the same time, Shanghai equity accounts will be able to purchase Hong Kong-listed stocks. 

I have generally thought that most of the talk of the internationalization of the yuan has been hyperbole.  The often cited swap lines have not been used.  Some talk about the rise of the yuan to settle trades and often cite the SWIFT data.  It may have tripled over the past year, but its share is still less than 2%.     The different offshore trade hubs (Canada has recently been granted this privilege) is only meaningful because of China's closed capital account and heavily managed currency regime. 

China, and many observers, want to have it both ways.  Hong Kong is a part of China, yet they want to say that more of the "trade" is settled in yuan, and somehow, this counts as internationalization of the yuan.  No other country counts the movement of goods and services within its own country as trade.  Economists wouldn't let them, but China is an often unexamined exception. 

That said, the Shanghai-Hong Kong link is important.  I would recognize it as the first opening up of the capital account since the QFII and RQFII facilities were first launched.  This is a significant development for global investors.  There are some outstanding issues, like capital gains tax, that still have to get sorted out.  However, the program is scalable, in terms of size and markets.  Some are already anticipating that the Shenzhen exchange could be next. 

It is easy to say that the Nikkei is being lifted by the BOJ's aggressive monetary policy.  However, until the middle of September, it was actually down for the year.  In the middle of October, it was at four-month lows.   The Nikkei is up more than 12% since not only the BOJ's announcement that it was stepping up its purchases of assets, including tripling the amount of equity ETFs was buying, but also the GPIF's portfolio allocation announcement.  

There had been talk since the start of the year that the GPIF would reduce its government bond holdings in favor of equities.      Many observers had thought it was a repeat of former Prime Minister Koizumi's attempt to structure the postal savings and boost returns.  However, the GPIF announcement was more aggressive than had been anticipated. 

Foreign investors have also participated in a significant way. The domestic developments plus the weakness of the yen provided a great inducement.   In the two weeks through November 7, foreign investors bought nearly $20 bln worth of Japanese shares, according to MOF data, which is the most for a two-week period since last November.