Global Macro: Dose of Chinese Medicine

NEW YORK ( TheStreet) -- If the potential removal of U.S. monetary stimulus wasn't enough of an excuse to sell riskier assets, this past weekend The People's Bank of China tightened liquidity measures, and on Monday, equity, commodity, and currency markets weakened to levels not seen since the beginning of the year.

The first chart below is of iShares FTSE China 25 Index Fund ( FXI) over Vanguard Total World Stock Index ETF ( VT). The chart measures the relative strength of Chinese equities versus a basket of world equities.

The pair has broadly sold off through much of 2013 as growth concerns, as well as structural changes to the Chinese economy, sent investors fleeing China-linked assets. That led to weakness in commodities and commodity-linked currencies. As demand for raw materials wanes in China, developing market exports decline.

Tighter liquidity measures enacted by the PBOC came in the form of allowing the seven-day SHIBOR, the benchmark rate at which banks in Shanghai lend to each other, to rise toward unstable levels around 12%.

The Chinese government is looking to shift policy, hoping to avoid speculative lending. It also is trying to create a more consumer-driven economy. That is no easy task, and alongside the removal of U.S. stimulus, global markets could see heightened volatility and relative weakness in Chinese equities over the next couple of quarters.

The next pair is of CurrencyShares Australian Dollar Trust ( FXA) over CurrencyShares Swiss Franc Trust ( FXF), which measures the strength of the Aussie dollar over the less volatile Swiss franc. Observing the price action of a commodity-linked currency over a traditional safe-haven currency allows an investor to gauge risk sentiment in global markets.

The chart below shows extreme underperformance of the Aussie dollar over the past three months. A stronger U.S. dollar has weighed on commodities, making them cheaper in dollar terms, which leads to price declines

Similarly, the lack of growth in China has led many to give up on fearing inflation and thus dump inflation-protected assets such as Treasury Inflation-Protected Securities and gold. When inflation expectations retreat, commodity-linked currencies show weakness.

With almost every developed economy releasing tepid data, it looks as if a meaningful return to inflation and thus commodity-linked currencies will not occur until late 2013 or early 2014.

The last pair is of Vanguard REIT Index ETF ( VNQ) over Guggenheim S&P 500 Equal Weight ( RSP), which measures the relative strength of a REIT index over an equal weight basket of S&P 500 stocks.

As Treasury yields rose and the yield curve steepened, this pair saw a large selloff. High-yielding assets, including dividend-paying products, lose appeal as rates rise.

Although the pair sold off in recent weeks, it generally rises as equity markets decline. Due to their fixed-income features, real estate investment trusts tend to show strength in the face of a selling environment. That allows the relative pair to be a good predictor of upcoming volatility, much like the VIX.

The inverse correlation may now be making its resurgence, as REITs outperformed other assets Monday during a heavy down day.

As volatility continues to reenter markets, and investor fear remains heightened, the chart below should rise to higher levels.

At the time of publication the author had no position in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Andrew Sachais' focus is on analyzing markets with global macro-based strategies. Sachais is a chief investment strategist and portfolio manager at the start-up fund, Satch Kapital Investments. The fund uses ETF's traded on the U.S. stock market to gain exposure to both domestic and foreign assets. His strategy takes into consideration global equity, commodity, currency and debt markets. Sachais is a senior at Georgetown University earning a degree in Economics.