Both levels and daily percent changes of emerging market ETF’s (dollar value of EM stock markets) track the Goldman Sachs US Financial Conditions Index during 2018. The relationship is not surprising, but the extremely high degree of correlation is striking.

1. EM index tracks GS financial conditions index

2. EM vs financial conditions

Within the overall correlation, though, there is a considerable degree of differentiation.

In China’s A-shares market, there is a sharp contrast between consumer-related sectors which turned in strong performance, and traditional state-owned enterprises (industrials, finance, and materials) which are squeezed by China’s moderately restrictive credit policy.

3. Shenzhen 300 index by sectors

4. Shenzhen index by sectors – 2

China’s growth rate of credit expansion has fallen sharply over the past several years, most markedly so in the shadow banking sector. Aggregate social financing was expanding at a rate of more than 20% in 2012 and is now expand at 10%, around the rate of growth of nominal GDP.

China evidently wants to restrain credit growth ahead of a general tightening of global monetary conditions and is willing to allow inefficient state-owned enterprises as well as some private enterprises to shrink or go bankrupt, rather than paper over losses as in the past.