Are emerging markets decoupling for real?

The US stock market still wields a fairly big influence on the equity markets around the world. But what is interesting is that even as developed markets have moved in step with the US, the emerging markets pack seems to be gradually shaking off the US influence and charting a path of its own.

The correlation between the MSCI US and MSCI EM index (consisting of 21 emerging market country indices including Brazil, China, Egypt, India, Indonesia, Korea, Malaysia, Russia, Taiwan, and Thailand), which was strong at 0.97 in 2008 and 2009, dropped to 0.86 in 2010.

Even as the EM index recorded 16 per cent returns in the year, the US index registered a return of 13 per cent only. Mulling the numbers of recent months, we find that the link between the US and EMs have weakened further.

In the November 2010-July 2011 period correlation between the MSCI US and MSCI EM index came down to 0.5. This suggests that the two indices didn't move in tandem very often.

The ‘decoupling' of the EMs from the developed world has been talked about for a long time now, given that the economic prospects of these markets have remained good even amidst the turmoil in the developed world. Even as EM countries looked a relatively better bet compared to developed markets in 2010 on their valuation and earnings prospects, it was the commodity price rally that changed the picture.

Rising inflation and spiralling interest rates specific to these countries have had investors pulling out of EMs.

However, the weakening correlation between EMs and the developed markets suggests that global investors may at last be beginning to analyse EMs on their own merits or demerits.

If commodity prices cool off with slowing growth in the developed world, inflation fears may recede. That may lure global investors back to the EMs once again.

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