Emerging Markets May Be Due For a Rest

While the broad market rally since March 2008 has been breathtaking, returns over the same period in emerging market stocks have been even more significant: (NYSE: EEM), the ETF that tracks the MSCI Emerging Markets Index, is up 42% from its low on March 2nd versus a 29% return for the S&P 500 over roughly the same period.

The chart below plots the 50-day moving average of the daily logarithmic return of EEM, subtracted from the daily logarithmic return of SPY.  A positive (negative) number indicates that emerging markets have consistently performed better (worse) than large-cap U.S. stocks over the period.

One detail that stands out is the tendency for high positive readings to dissipate fairly quickly, which has not been the case for negative readings.  Compare the tops in early 2006, early 2008, and early 2009 with the longer troughs in April 2004, April 2006, and of course the crash of 2008.  There are obviously numerous fundamental factors driving the relative performance of these indexes, none of which are addressed in a historical chart like this.  However, if past tendencies are any guide, we can expect the difference in the average daily performance of EEM and SPY to decline from its current 50-day average of 0.37%. Preliminary backtests suggest that pair trades exploiting the convergence of returns have been profitable, if infrequent.

 |  |