The correlation of the oil price, the US dollar and emerging market equities looks to have broken down as emerging stockmarkets have held up well in the face of what historically could have been a perfect storm.
Analysis from Hermes Fund Managers shows that emerging market equities have historically closely tracked both the price of oil and the relative strength of the dollar versus emerging market currencies.
This means that when oil sold off or the dollar gained value, emerging market equities traditionally sold off.
But Hermes’s data shows that since mid-2014, the correlation has begun to break down as emerging market equities have not sold off in spite of a dramatic collapse in the price of oil and the soaring value of the dollar.
The price of oil has plunged by 45.8 per cent in dollar terms since the end of June 2014.
In the same period, the value of the trade-weighted index of emerging market currencies has fallen by 15.4 per cent compared with the US dollar. But the MSCI Emerging Markets index has actually risen by 4.9 per cent on a local currency basis, data from FE Analytics shows.
Oliver Leyland, senior investment analyst on the Hermes Emerging Markets fund, said that while the correlation had “broken down”, what was still unclear was whether such divergence was temporary or sustainable.
In terms of the oil price slide, Mr Leyland said there could be a sustainable break in correlations, both because of the nature of the oil price slide and the changing composition of the emerging market index.
While most recent oil price falls had been sparked by a drop in demand, such as the financial crisis, Mr Leyland said the current drop came from a glut of new supply instead.
Meanwhile, the MSCI Emerging Markets index currently has only an 8 per cent weighting to oil and gas stocks, down from 18 per cent in 2007.
The proportion of the index taken up by oil-importing countries, such as China and India, has risen from 59 per cent to 70 per cent, while oil-exporting countries, such as Russia and Brazil, have faded. Thus the sector is far less exposed to the commodity price than before.
The situation is slightly different for income-focused emerging market equities, where oil and gas stocks account for 26 per cent of payouts from emerging market companies.
Mr Leyland also pointed out that the historic exposure emerging markets had to the dollar was based on current account deficits and high levels of external debt, primarily denominated in dollars, which left them vulnerable when the dollar rose and so their borrowing costs rose.
“The majority of the benchmark – China, Taiwan, Korea, Philippines, Malaysia, Mexico and Russia – has minimal or no deficits, high levels of reserves and low levels of dollar debt at the national level,” he said.
Mr Leyland said the evidence suggested the general emerging market resilience in the face of lower oil and a stronger dollar should continue to be higher than in the past
“We do not deny the potential for pockets of stress in mismanaged emerging economies that have become too reliant on energy exports, such as Russia, Venezuela and Nigeria,” he said.
“But all else being equal, emerging market equities have the potential to perform resiliently.”
Is the moniker ‘emerging markets’ past its sell-by date?
Emerging markets as a catch-all term for stockmarkets not considered as developed may have reached its nadir of usefulness.
That was the assertion of Artemis global income manager Jacob de Tusch-Lec last month as he pointed to the wildly different economic and market drivers for the major countries in the index.
JPMorgan’s head of emerging markets, Richard Titherington, echoed those views last week, emphasising the need for “differentiation and a selective approach” in 2015.
He said: “One need look no further than the difference between India and Brazil in the past year to understand the need to be selective.
“Both countries held elections that had the potential to reshape the future of their economies.
“One chose market-friendly change and has rallied significantly; the other chose the status quo and has been a colossal underperformer.”
