Global Market Performance And U.S. Interest Rates

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Posted: Jun 26, 2020 9:53 AM
Global Market Performance And U.S. Interest Rates

Source: AP Photo/Cliff Owen, File

We've recently done some analysis looking at performance of Emerging Markets vs. Developed Markets. By taking historical returns based on available data and comparing average returns from EM stock indices to those of DM countries during a six-month period, we saw a few historical patterns emerge:

  • First, EM tends to beat DM, but not consistently, as discussed in Do Emerging Markets Beat Developed Markets? Over time the overperformance is substantial, at an average of about 3.5% annualized return, but it occurs slightly less than 6 out of 10 times.
  • Second, EM tends to beat DM at periods after down markets across both. In other words, if the average return for the EM countries and the average return for the DM countries are both down, in the following period EM tends to beat DM more than the historic average. In plain terms: The period after a global crash is a relatively good environment for EM investors, generally speaking.

Now we’re going to look at another factor which helps us identify periods after which EM has tended to beat DM by larger margins than usual: interest rate expectations, specifically in the United States. In other words, what we're trying to learn is whether the U.S. interest rates are so powerful as to be one of the drivers of global market performance.

Let's look at the relationship between interest rate expectations and various other numbers. The grid below shows correlations, which is a measure of whether numbers move in sync with one another or not. If these numbers move perfectly in sync with one another, the correlation will be 1. If they move perfectly opposite one another, the number will be -1.

As a crosscheck, we can look in the upper left hand block and we see that the label on the row is the same as the label on the column. This means that we are showing the correlation between a certain factor and itself. Of course, when comparing the same data to itself, the correlation has to be a perfect 1, which we can see it is.


Interest Rate Expectations

Adjusted Bond Yields

Dollar Strength

Copper Demand Model

Capital Gains by Country

Total Returns by Country

Interest Rate Expectations

1

0.287

0.141

0.239

0.027

0.172

Adjusted Bond Yields

0.287

1

-0.153

0.417

0.033

0.095

Dollar Strength

0.141

-0.153

1

-0.578

-0.007

-0.512

Copper Demand Model

0.239

0.417

-0.578

1

-0.001

0.475

Capital Gains by Country

0.027

0.033

-0.007

-0.001

1

0.021

Total Returns by Country

0.172

0.095

-0.512

0.475

0.021

1

What we see is that interest expectations move in almost a 29% correlation with actual bond yields. It's not a perfect fit, but it is positive, which we would expect. There is no universally agreed upon standard of what would be considered a good correlation, but when it comes to something as big and complicated as global markets with many factors causing many effects, a correlation rate like this looks quite good in our view.

We also see a fairly good correlation between time periods when our copper price model shows that the price of the metal adjusted for various factors is signaling good global growth, and the interest expectations number we use. In other words, the tendency is that when the global copper market is signaling bad times, investors expect the U.S. to cut rates and when it is signaling good times, investors expect the Fed to hike rates.

We also see a discernible, but not very strong, correlation between interest rate expectations and the strength of the dollar. This is expected. Economists debate about the nature of the cause and effect. Some say that higher rates mean that this makes investing in the U.S. interest rate environment more attractive. In other words, wouldn't you move your money from Bank A to Bank B if Bank B offered higher rates for your savings account? Of course, that's an overly simplified view because Bank A and Bank B might not be equally risky.

The other theory is that the Fed uses these interest rates as the way to create more money and inject it into the system or to take money out of the system (mostly the former), and so raising rates means fewer dollars, and fewer dollars (all other things being equal) means dollars are worth more. Whatever the reasons, there is a positive correlation.

Next time, we'll look at how that might affect the trade-off between EM investment and DM investment.