Today’s soaring inflation, rising rates of interest and multi-billion dollar investment fraud cases are an excellent reminder that a transparent understanding of the past helps us higher predict the long run. In fact, it could actually provide a reliable basis on which we will make portfolio allocation decisions.
Therefore, we’d like to maintain an in depth eye on the relative and absolute performance of varied stock markets up to now. After all, what drives the market cycle if not the relative underperformance and outperformance of various assets?
With this in mind, the stock market universe is categorized in a different way by region, country, sector, market capitalization and magnificence. The established geographical segmentation divides the world into frontier, emerging and developed markets.
What determines the name of a rustic? The MSCI market classification framework focuses on three criteria: economic development, size and liquidity, and market accessibility. The latter is a function of three components: openness to foreign ownership, ease of capital inflows and outflows, and efficiency and stability of the institutional framework.
It hasn’t all the time been easy or low cost to speculate at a regional or country level, but because of technological advances and the event of Exchange Traded Funds (ETFs), retail investors now have significantly better, if not unlimited, access to the various segments of the stock market universe.
How have these geographic segments performed relative to one another in recent market cycles?
Benchmark investment ability
| Market index | Investable ETF |
| MSCI ACWI and Frontier Markets Index | Not available |
| MSCI ACWI | iShares MSCI ACWI ETF (ACWI) |
| MSCI World Index | iShares MSCI World ETF (URTH) |
| MSCI Emerging Markets | iShares MSCI Emerging Markets ETF (EEM) |
| MSCI Frontier Markets | Not available |
| MSCI Frontier and chosen emerging markets | iShares MSCI Frontier and Select EM ETF (FM) |
Launched on April 7, 2003, the iShares MSCI Emerging Markets ETF (EEM) achieved a cumulative return of 381% through December 31, 2010. In comparison, the iShares Core S&P 500 ETF (IVV) returned 66% over the identical sample period.
So on this particular market cycle, emerging markets performed significantly better than their developed counterparts.
EEM vs. IVV
April 7, 2003 to December 31, 2010
But let’s take it a step further and compare the relative performance or strength of EEM and IVV using intermarket evaluation. This allows us to tell apart between different trend periods by identifying key turning points of their price charts. The relative strength of EEM versus IVV over the sample period shows a crucial turning point in early 2011, as detailed within the chart below.
Relative strength of EEM vs. IVV
April 12, 2003 to December 7, 2022
Emerging markets as a category were outperforming the S&P 500 until this turning point in 2011. Since then, the downward trend has shown their underperformance.
Frontier markets have also achieved higher returns than other geographic segments at various times. For example, from 2002 to 2007, the MSCI Frontier Markets Index outperformed each the MSCI EM and MSCI World indexes. Some frontier markets could again outperform each developed and emerging markets.
This sort of intermarket evaluation has applications that reach far beyond geographic segments. This allows us to discover similar turning points relative to the S&P 500 within the energy, technology and materials sectors. For example, the Energy Select Sector SPDR Fund (XLE) has underperformed the S&P 500 for years. But the connection modified in early 2021, and the energy sector proxy has outperformed the benchmark index ever since.
The technology sector’s relationship to the S&P 500 turned in the wrong way. After years of beating the S&P 500, our tech proxy, the Technology Select Sector SPDR Fund (XLK), began to underperform in early 2022. In commodities, the S&P GSCI Commodity-Indexed Trust ETF went from underperforming to outperforming the S&P 500 at the tip of April 2020.
Such evaluation can function the premise for tactical asset allocation decisions. We may adjust the share of the portfolio held inside an asset class or between asset classes based on these changing market opportunities.
Of course, we’d like to know each the index and the relative performance of its underlying components. For example, country aspects could have a greater impact on returns than industry aspects, while returns in a frontier market country could also be as a result of country-specific quite than global aspects. Therefore, lively investors should examine the characteristics of individual countries quite than simply investing in a broad frontier or emerging market index. Individual country indices have gotten increasingly accessible via ETFs, but not all are equally investable. For example, Saudi Arabia’s stock exchange, Tadawul, existed long before the iShares MSCI Saudi Arabia ETF (KSA) began trading in 2015.
A bigger lesson emerges from these turning points (when for some reason the switch is flipped and the dynamics between geographic segments change): relationships in the worldwide stock market universe usually are not static. Just like up to now, there shall be critical turning points in the long run. One or one other segment will exhibit periods of sustained outperformance in comparison with its competitors. For this reason, adjusting our allocations to emerging or frontier markets can sometimes improve risk-adjusted returns.
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Photo credit: ©Getty Images/ Luigi Masella / EyeEm
