Index Construction Drives EM Outperformance

JC Parets
October 31, 2020

One of the most valuable parts of our day has become reading The Chart Report India daily email.

It's impossible to catch everything that's going on in the markets on a daily basis, but we know that The Chart Report India will help us stay on top of the most significant market insights.

In just a few minutes of reading, we get a recap of what the top technicians in the world are watching in the Indian markets.

Like this tweet below from Nautilus Research, which was featured in the October 28th daily email.

In this case, Emerging Markets outperformance has been something we've been talking about for a while, but seeing its isolated performance relative to Europe really helped highlight what's driving the weakness.

We wrote more about this relationship two days ago (Global Yields Weighing On Equities) and the post below will expand on our thoughts, this time focusing on index construction.

But to bring it back full circle, these two posts and their related research were inspired by charts shared in The Chart Report India email. It's a great free tool to stay on top of market happenings.

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Now, let's get into today's post.

The German DAX on a 1-hour timeframe looks like a major topping pattern, with prices making about 5-month lows this week and closing near the lows. And it's not the only European index breaking down significantly.

Click on the chart to enlarge view.

This has a lot to do with the index composition of many European countries. Low Yields and narrow Yield Curves are putting pressure on their Financial sectors...which happens to be a large weighting in the indices.

The broadest way to view this theme is by looking at Emerging Markets vs Developed Markets Ex-North America making 7-year highs.

And Emerging Markets relative to European Markets looks even better.

It's simply an exaggerated version of the chart above because European Markets have been the weakest part of the Developed Market basket for quite some time.

Again, the reason for this also comes down to index construction. The Asian Pacific countries within the EAFE Index have a much larger weighting towards Tech and less Financial exposure.

Even BRICs are outperforming Europe handsomely (h/t our intern @GrantHawkridge for the charts).

At the end of the day, it comes back to a Technology vs Financials story. Just like the Growth vs Value discussion we've been having for years.

Owning things with more Tech & Consumer exposure and fewer Financials exposure continues to work, regardless of where in the world and at what level (index, sector, individual stock)...the story remains the same.

As usual, things need not be that complicated. Sometimes it's as simple as knowing what you own and what you don't.

As always, thanks for reading and please let us know if you have any questions!

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