Guess Which is Not the Worst Performing Area of the Global Equity Market this Year?

One major trend availing itself in the global equity markets may be surprising: the stark out-performance of emerging markets.

We’ve started to write a bit here and there about the relative performance differentials availing themselves in what has undoubtedly been a turbulent year. The reason we’ve spent time on this subject is because often at important market turning points such as during volatile periods there is a distinct change in leadership in the equity markets. After a four plus year bear market, emerging markets may be “emerging” from their slumber. Indeed, year-to-date EM stocks in aggregate are down just 5.55%, second only to the S&P 500 among major indexes (chart 1).

Yet, under the surface there is an even more striking trend taking place: the out-performance of EM counter-cyclical stocks (consumer staples, health care, telecom, and utilities) relative to EM cyclical stocks. Before the pause over the last few days EM counter-cyclicals had outperformed EM cyclicals by 7% YTD and put in a new relative strength high (chart 2).

So we now have 1) the out-performance of EMs generally and 2) the out-performance of EM counter-cyclicals specifically. What does this mean for investors? First, it suggests that investors should start to think seriously about revising their easiest underweight decision over the last few years. Secondly, it means investors should think seriously about NOT taking the easiest route to EM exposure in the form of cap-weighted index ETFs or their closet indexing cousins, which have scant exposure to counter-cyclical stocks. Instead, investors may be well served to focus instead on funds with the flexibility to selectively allocate to EMs or EM smart beta indexes with a tilt away from last cycle’s winners (financials, commodities, materials).