Wednesday 26 October 2016

Convergence the trend as emerging markets track US equities

Andre Tartar, Wei Lu and Elena Popina

Published 23/08/2016 | 02:30

Traders work on the floor of the New York Stock Exchange (NYSE). Photo: Reuters
Traders work on the floor of the New York Stock Exchange (NYSE). Photo: Reuters

Traditionally investors looked to emerging markets as a higher growth alternative and even hedge to investing in big, core, developed economies.

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But in the age of globalisation, diversity is harder to come by. That poses a challenge for an emerging markets investor. Bloomberg's Stock Correlation Tracker compares the benchmark equity indices in 84 countries with the S&P 500 index over a 10-year period and found that 88pc of them were positively correlated with the US market index in the first half of this year. That's up from 82pc a decade ago.

Much of this convergence is happening in emerging or frontier markets, where economic growth has slowed dramatically - moderating closer toward the US pace - including several Middle Eastern indices that used to move in the opposite direction to the S&P.

"Emerging markets were once seen as the Wild West of investing, the markets that are hard to understand and impossible to predict," said Timothy Ghriskey, who helps manage $1.5bn as chief investment officer at Solaris Asset Management in New York.

That's no longer the case. The most striking examples are oil-dependent economies like Saudi Arabia, the United Arab Emirates, Qatar, Kuwait and Bahrain.

"We see more and more often that the forces that impact the developed markets influence the emerging markets as well," he said. In short, "emerging markets are no longer the markets that exist in isolation to the US market."

Europe is highly correlated to the US, especially Germany. Correlation has risen the most in the Middle East and Asia, but here is a surprise, it is falling in Latin America's largest economies particularly hard hit by the commodity crash.

Among the 10 positively-correlated markets that have moved closest to the S&P 500 in 10 years, none is more important than China, which has seen its correlation coefficient increase from 0.11 in 2006 to 0.55 so far this year.

How can one account for the Latin America outlier? Well, it comes down to diversity and how the indices are constructed. Taiwan, which is highly correlated to the S&P, may be a small island but it has 856 listed companies.

In the cases of Brazil and Chile, their benchmark indices have actually become less representative of their economies since 2006, shedding more than 30pc of gross domestic product from their respective market capitalisations.

For traders looking to hedge their US equity bets, there are but 10 markets left this year that are negatively correlated to the S&P 500, according to the Bloomberg Stock Correlation Tracker: Morocco, Tanzania, and Malta to name a few. Instead, they may want to take a closer look at markets that are now less correlated than a decade ago: Indonesia and Turkey.

Ironically, this all comes as investors are piling into emerging-market debt at the fastest pace on record. But its hardly a case of throwing caution to the wind. Many of the current investor crop are more cautious than they look. The mutual fund with the biggest increase in assets is also the most averse to taking risks.

Pictet Asset Management's global emerging-market bond fund swelled by 44pc to $8.1bn since the start of the year.

The Geneva-based fund has the lowest risk rating of its 12 biggest peers in developing countries tracked by Morningstar. (Bloomberg)

Irish Independent

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