“EM turmoil,” “Fragile Five,” “current account deficits,” “global imbalances,” are some of the terms that have become more commonplace in our daily lexicon during the past few days of the global collapse in equities.
More ominously, emerging market equities and US equities, which usually move up or down in lock-step (at least they did so in 20 of the past 25 years), diverged in 2013 – EM equities were down whereas the S&P500 was off to the races.
That may have been a sign, because as of late January, EM equities appear to have been black-listed by investors and have been in a kind of free fall. This had a follow-through effect on developed market equities, including the S&P500.
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The history of past EM pullbacks
“As a guide to navigating the US equity market, should these concerns persist, we examined the historical example in 19 EM equity pullbacks of 5% or greater in the past decade,” say Goldman Sachs analysts Ben Snider, David J Kostin, Stuart Kaiser, Amanda Sneider, Rima Reddy and Aaron Woodside in their recent research note “EM pullbacks and the S&P 500: Past lessons for current investors.”
Key takeaways from the past
Analysis shows that the MSCI generally declines as much as half of the MSCI EM index.
Moreover, the fall is precipitated by sentiment rather than valuation concerns, because only 5% of S&P 500 sales derive from EM (chart 5 below).
“Changes in forward P/E explain the price action of the aggregate S&P 500 in most historical examples, rather than a re-rating of demand growth through EPS expectations,” point out the Goldman Sachs Group Inc (NYSE:GS) analysts, referring to chart 4 above.
Also, domestically oriented stocks such as those represented in Goldman’s GSTHAINT basket, perform better than the market and EM-exposed stocks in Goldman’s GSTHBRIC basket (chart below).
The Goldman analysts observe that whenever EM equities fall by 5% or more, sectors such as Health Care, Utilities and Consumer Staples, which are highly defensive and domestic consumption stories, performed well.
On the other hand, commodity oriented and cyclical sectors such as Materials, Energy and Financials were the worst sufferers.
Note of caution
Well, past history is no guarantee of future performance, and Goldman Sachs Group Inc (NYSE:GS) takes pains to point out that in the current situation correlation patterns between US and EM equities appear to be breaking down – primarily due to the improvement in US economic growth and the Fed tapering.