Emerging-market stocks are high-beta assets, and in times of general volatility, as we’ve seen over the past couple of years, they exhibit really high volatility. You need a strong stomach to invest in them, and you’re likely to get whipsawed quite a lot. But as a result, trying to extrapolate a big-picture global macroeconomic forecast from a relatively short-term movement in emerging-market stock indices is a fool’s game. I don’t think that EM stocks have ever been good forecasters of anything; there’s certainly no reason to believe they’re demonstrating something in particular right now.
Decoupling is what happened in the 1990s, when US equities soared as the emerging markets (and Japan) tanked. Between January 1994 and December 2000, MSCI Emerging markets index (ETF: EEM) returned -6.6%, annualized. During the same period, the S&P returned 18.25%, average annualized! That is decoupling! Needless to say, the US is a large economy with a large domestic economic and financial base. It can withstand, even thrive, amid collapsing Asian economies. That is not the case with emerging markets today. The US is still large in relation to the world economy and the EMs are not big enough yet.
However, from Jan. 2001, emerging markets have returned 10.5%, annualized, whereas the S&P 500 has posted a -3.1% loss, annualized. That is a huge outperformance. This despite, the horrendous 54% collapse in the EM index last year. Yet one could quibble that by picking 2001, we are comparing S&P at its worst overvaluation to EMs at their relative low valuation point. There is probably some truth to that. If however, we want to shorten the time frame, then we also need to adjust the portfolio size for relative volatilities. EM volatility (historical) is about 1.5 to 2 times (depending on the time frame and time period of analysis) that of S&P. So, let us see how EEM compared with SSO (double long S&P).
Essentially, if you had gone long EEM and short SSO, you would have cleaned up! Especially in 2008! This after the emerging markets had a blow off top in 2007. Amazingly, during the S&P's latest bull phase, the trade would have underperformed, although not something that a normal investor cannot bear. Another point to note: emerging markets bottomed in November and never went below that (although individual EMs, such as Russia did). whereas the S&P broke decisively below its November low in March 2009. So, decoupling is bunk, but there might be some germ of an idea there that needs development. In any case, you can make money off it. I think that S&P has a tremendous down leg from here. If you don't have the stomach to play it straight. You could hedge it with EM longs. Who knows, it might turn out to be a Texas hedge--make money on both sides of the trade!
