There is an obvious appeal for lead indicators from investors and traders worldwide. Well, here’s the latest to join the pack: the Chinese equity markets.

Geoffrey Dennis and Jason Press, US-based analysts at Citigroup Inc., say in a report dated 3 August: “The Chinese equity market has shown clear signs of leading global equity markets at turning points over the past three years (the late-2007 peak, the late-2008 trough and the recent peak in markets at end-2009, start-2010)."

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In late 2007, the MSCI All Country World index and the MSCI Global Emerging Markets (GEM) index peaked in end-October, around 15 days after the Shanghai Composite had reached its peak. In late 2008, the Shanghai Composite Index bottomed on 4 November, around 16 days before the MSCI All Country World index reached its bottom. And while the MSCI All Country World and MSCI GEM indices peaked in mid-January 2010, the Shanghai Composite Index peaked long before on 23 November 2009.

The analysts add: “As equity markets should act as a leading indicator of broader economic growth trends, it seems, therefore, that the Chinese equity market has recently become the leading indicator of the leading indicators."

Isn’t this saying too much of a market that’s closed to international capital flows? Citigroup has used the Shanghai Composite index for its analysis, an index which is made up of all listed stocks on the Shanghai Stock Exchange. All of these are A shares, which can be bought only by Chinese citizens.

The MSCI China index, which include H shares listed on Hong Kong and which can be bought by international investors, behaved differently in the three turning points for the markets mentioned above.

Of the three turning points mentioned above, the MSCI China index’s peak and trough coincided with the GEM index on two occasions. And while the MSCI China index also peaked earlier in November, the index rose to within half a per cent of this peak in mid-January, when the GEM index peaked.

It seems strange that a market dominated by Chinese local investors should act as a lead indicator for global equity markets. Even so, the analysts say that the evidence of Chinese market leadership at market turning points is convincing, if not overwhelming, adding that anecdotal evidence can also be drawn upon to suggest that the local Chinese equity market acts as a major driver of investor sentiment at turning points in the market.

Staying with this theme, they point to the recent turnaround in sentiment in the Chinese markets as being a major support for improved overall global sentiment in the past one month. The Shanghai Composite Index had bottomed on 5 July and has rallied by 11% since.

This time around, though, it hasn’t acted as a lead indicator. The MSCI All Country World index, too, bottomed on the same day. And the MSCI GEM and China indices bottomed long ago on 25 May.

While the Shanghai Composite hasn’t acted as a lead indicator, the rally in this index is apparently supporting investor sentiment.

Is any of this visible in the Indian markets?

The MSCI India markets have rallied by 17% since 25 May, and a large part of those gains—almost two-thirds—came before 5 July. But interestingly, foreign investment flows have risen since 5 July. The average net investment by foreign institutional investors in the secondary markets stood at Rs384 crore between 25 May and 5 July, and this has jumped to Rs558 crore in the past month, since the Shanghai Composite Index started rallying.

While all of the above data doesn’t establish any conclusive link, it does appear that the health of the Chinese markets affects investor sentiment, and for this reason, it perhaps makes sense to keep an eye on the Shanghai Composite Index.

Graphic by Paras Jain/Mint

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