Emerging market equities are notoriously volatile, but even so, the ongoing eight-day losing streak for the MSCI Emerging Markets index is notable, particularly for Canadian investors.
The train of daily declines is the longest since November of last year and the second longest since the end of the financial crisis. The 10-year-old tight relationship between developing world stocks and the S&P/TSX Composite means domestic investors should start hoping for the MSCI index to bottom out and start climbing.
The chart below shows the remarkable 10-year correlation between Canadian and emerging markets stocks (the measure of the correlation, or R-squared is 0.77 using weekly data). The resource-intensive economic growth in the developing world has been a clear boost to the mining and energy stocks that make up 38 per cent of the domestic benchmark.
SOURCE: Scott Barlow/Bloomberg
Beginning in late 2013, the TSX broke the pattern a bit. The MSCI Emerging Markets Index and the TSX rose, but the Canadian benchmark shot ahead. In large part, this reflected a change in market leadership for the TSX. Banks and energy stocks more than picked up the slack for the falling mining stocks that were most sensitive to developing world growth.
It's energy stocks that now pose the dilemma for investors. The table below shows the top 10 most positive contributors to S&P/TSX performance since November. Suncor Energy Inc. and Canadian Natural Resources are on the list but the stocks are now confronted with a rapidly falling commodity price.
Railways profits and stock prices were boosted by the surge in crude-by-rail transport, so strength in the sector is, at least in part, a function of energy prices. To the extent that previous higher oil prices drove higher production, and the need for more transport, growth in railway profits could slow because of the commodity price decline.
The recent drop in oil prices, if sustained, could leave bank stocks as the only force pushing the market higher. This would see the divergence on the chart narrow.
Domestic investors should pay close attention to the relative performance of emerging markets and Canadian equities. Continued weakness in the MSCI Emerging markets index, combined with the weaker oil price, point to volatile conditions for Canadian equities.
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