Strong Dollar Could Alter Capital Flows
Once you invest outside the United States, the impact of currency fluctuations
becomes more pronounced. All things being equal, emerging market economies
would prefer to see a weak U.S. Dollar. From Reuters:
Rising rates in the United States could prompt heavy flows of investment
out of emerging markets where investors flocked in search of higher
returns. A stronger dollar also erodes the appeal of holding emerging
market currencies. Minutes from the Fed's last meeting fueled speculation
that interest rates could soon start rising and news also emerged
that two Bank of England policymakers had voted for higher interest
rates earlier this month.
Why Be Different When Different Is Worse?
The facts are since the second half of 2010, emerging markets (EEM) have significantly
underperformed the S&P 500 (SPY). At some point, the odds and correlations
tell us the trend will reverse in favor of emerging markets. However, trying
to guess, forecast, or anticipate a reversal has been a painful process in
recent years.
Some Progress, But Hurdles Remain
According to the graph from stockcharts.com below,
emerging markets and the S&P 500 have performed in a very similar manner
YTD.
Before we are willing to look at emerging markets more seriously from a longer-term
investment perspective, we prefer to see the ratio of EEM to the S&P
500 break above the longer-term bearish trend channel shown in blue below.
Pulling Back On The Reins
At some point, professional investors begin to question, "Am I being compensated
for investing in emerging markets relative to developed markets?" One of
the biggest players on the investment stage seems to be having some doubts.
From Bloomberg:
Norway's $880 billion sovereign wealth fund, the world's largest, is
slowing its expansion into emerging markets as it scales back a two-year
mission to tap into the fastest growing markets. "We are gradually
picking up some new markets but at a less rapid pace than we did
at the beginning of the year," Yngve Slyngstad, the fund's chief
executive officer, said yesterday in an interview after a press conference
in Oslo.
Guideposts To Monitor Progress
The blue horizontal line in the chart below tells us there has been no advantage
to owning emerging markets relative to the S&P 500 over the last year
or so. We prefer to see evidence of an advantage before considering shifting
capital out of the United States. If the EEM/SPY ratio can break above the
orange box below that would be a good first step in a "prove it to me" campaign.
Better yet, a break above the red box would represent a significant higher
high.
Investment Implications - The Weight Of The Evidence
With the most important event of the week, Jackson
Hole, still on tap, equities have a big hurdle to cross Friday. Our
allocations of stocks (VTI) and leading sectors, such as technology (XLK),
remain in line with the evidence we had in hand as of Thursday's close.
A positive reaction to Janet Yellen's remarks could prompt another reduction
in our cash holdings
