Following up on Tuesday's post discussing how emerging markets were holding on for dear life, we wanted to highlight their relative strength compared to the S&P 500. The chart below shows the relative strength of the emerging market ETF (NYSEARCA:EEM) compared to the S&P 500 ETF (NYSEARCA:SPY). A rising line indicates that emerging markets are outperforming the S&P 500 and vice versa when the line is falling.
The current bull market in US equities started out with emerging markets outperforming the S&P 500. After the first year and a half, though, there was a notable shift where the US took the leadership role. Since then, it has been a pretty steady decline in relative strength of emerging markets. In fact, in early July, EEM hit a bull market low on a relative basis.
The lower chart shows the relative strength of emerging markets and the S&P 500 over just the last six months. Here, we saw steady underperformance on the part of EEM through the summer. Towards the end of the summer, though, the S&P 500 faltered and emerging markets started to outperform through mid-October. Since mid-October, US equities have once again taken the leadership role and EEM is back near multi-year lows on a relative basis. What is important to note here is that in the period leading up to the government shutdown and debate over the debt ceiling, investors rotated out of US stocks. However, right when the market's caught wind of the deal on the shutdown and debt ceiling, investors quickly rotated back into the S&P 500.
Looking ahead to early next year when the debt ceiling will have to be raised again (by 2/7), investors should keep the last six months in mind. If signs start to point towards another protracted and messy debate over the debt ceiling, we would expect US equities to start underperforming again early next year. If, however, politicians in Washington can miraculously work out an agreement in a smooth manner, we would expect US equities to continue outperforming.