It appears that investors are beginning to price in risk again given concerns over an oil spike resulting from fears over supply disruptions due to continued and rolling revolutions occurring in the Middle East. While Egypt's protests were largely ignored from an equity standpoint, Libya appears more violent and is having a bigger impact on buyer psychology. The question is whether mentality has actually firmly flipped and if we are still in the “buy the dips” mode.
Let's consider the possibility that we are in the midst of a correction now. After all, unrest in the Middle East and fear over oil price shocks seems as good a reason as any for markets to sell off, particularly given the phenomenal run up equities have had since September of last year.
From a macro global perspective, which equity market may be most vulnerable? To get a sense, let's take a look at the price ratio of Emerging Markets (EEM) to the S&P 500 (IVV). As a reminder, a rising price ratio means the numerator/EEM is outperforming (up more/down less) the denominator/IVV.
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Notice the significant underperformance of emerging markets since mid-October relative to the U.S. The price ratio has effectively given back all of the strength seen from June of 2010. Much of this weakness has been attributable to the cost of soft commodities, particularly agriculture, where we've experienced ever increasing prices in food. Turn on any major financial network and you'll likely hear how this analyst or that portfolio manager is downbeat on emerging markets.
The time to be bearish on them was four months ago. Interestingly enough, while markets have been volatile, emerging markets stopped underperforming the U.S. in early February. The implication here is that the correction could really cause the U.S. to underperform emerging markets in a declining equity price environment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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