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Financial markets are often similarly anatomized as if they were a single organism. During times of market dislocation there is much talk of “contagion” – the notion that a panic in some distant periphery, such as the domestic Chinese stock market, can infect and undermine the entire body. The idea of contagion is intuitively appealing in an interconnected, high velocity, 24/7, globalized financial world. However, the separation of cause and effect is often difficult.
The footprints of institutional investors across the markets are the best guide we have. According to the State Street Global Markets’ Equity Flow Indicator, cross-border investors sold the Chinese market in the nine sessions leading up to the 9 percent correction on February 27th. This was part of a broader reallocation away from emerging markets that had already started and has accelerated since (see Chart 1).
This suggests institutional investors had to some extent anticipated the price action that has unfolded in markets and had started to reorient their portfolios. The MSCI China Index was up more than 78 percent in 2006 but was lagging the MSCI EM Index even before February 27th. More broadly, emerging equity markets outperformed developed for five straight years between the start of 2001 and the end of 2006. However, in 2007, even before February 27th the MSCI EM Index was lagging the developed market MSCI World Index, with a return of 3.15 percent versus 4.06 percent in local currency terms. ...................... To view our full article Click here
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