With the surge in emerging markets — as reflected by funds like VWO (quote) and EEM (quote) — and some significant moves up in India and China, it is natural to wonder if we are near some kind of a near-term top. Is the move over or just getting started?
A lot of investors are scratching their heads over the most recent surge in equity prices and the reflationary environment we now suddenly find ourselves in.
To answer the question of whether there is more potential for higher highs, let’s think about emerging market equities not from the standpoint of absolute gains, but rather in terms of performance relative to defensive sectors that do well in bear markets.
As a reminder, a rising price ratio means the numerator/IPS is outperforming — up more or down less — the denominator/VWO.
Consumer staples isn’t quite a sector that investors get excited over, but the relative performance of the group can be telling about risk sentiment and the potential for further gains/losses in broader stock market averages.
Generally speaking, because of lower economic elasticity and beta to the economy, consumer staples stocks tend to outperform in declines and when there are fears of a global growth slowdown.
Notice how the ratio above substantially underperformed in the first half of 2009 as the global reflation trade came in full force and equities rallied off of their crisis lows post-Lehman. The ratio then went sideways before bottoming last year when the deflation pulse began to beat.
IPS then staged a massive leadership rally, far outperforming emerging market stocks.
Notice the far right of the chart now. VWO has now significantly OUTperformed IPS in a clear downtrend of the ratio.
But perhaps more telling is how much further the ratio can fall. If we assume we’re headed for a period of mean reversion, then the ratio can fall back to its lows some time this year.
How would that happen? More aggressive risk-taking on VWO and continued bets on growth and reflation. So is the rally done in emerging markets? Based on the potential for the above ratio to fall further, chances are that the bulls have room left to run.
by Michael A. Gayed CFA for Emerging Money
The author, Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing. The commentary does not constitute individualized advice. The opinions herein are not personalized recommendations to buy, sell or hold securities.