Recoupling: The Real Significance Of This Week’s Action

With so much going on in in the here and now, I think it’s important to go beyond all the volatility in stock markets to understand the bigger picture implications of the week’s action.

We shouldn’t forget that the big selloff on Tuesday in US markets was in response to massive selloffs overseas (See, for example, “Fears of a Recession Spark A Global Selloff; New Pressures on the Fed” (subscription required), The Wall Street Journal, Tuesday January 22, 2008, A1).

Emerging markets stocks have been the leaders in this bull market, massively outperforming developed market stocks (EEM vs. SPY 5 Year Chart).  And, even of late, they’ve held up on the idea of “decoupling”, that their economies are no longer dependent on the US to continue growing.

But lately, and especially this week, the idea of “decoupling” has come under scrutiny and been subject to doubt (EEM vs SPY 10 Day Chart).

If this thesis is indeed wrong and emerging markets are more connected to the US than believed, we could see a lot more downside in emerging markets.

I know that most investors and financial advisors have been big believers and proponents of diversification through international exposure.  There is a lot of money in this trade that, if it reverses, could mean a lot of pain.

On this subject, I want to recommend two excellent articles:

“Developing Economies Face Reckoning As US Stumbles” (subscription required), The Wall Street Journal, January 24, 2008, A1

“The Greatest Economic Boom Ever”, Rich Karlgaard, Fortune Magazine , July 12, 2007

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