Friday, February 29, 2008 2 comments ++[ CLICK TO COMMENT ]++

Decoupling Theory Weakening

I have never been one to accept the decoupling theory. In case you are not familiar, this is the theory that postulates that emerging markets do not depend on the US economy anymore. The thinking is that one can avoid market corrections by investing in foreign countries.

The first few months of this year has put that theory to test and it hasn't held up well so far. Plotted below are the US$ year-to-date returns for some key countries (using Dow Jones indexes).



As things stand at the end of February, USA had a return of -9.2% versus -7.8% for the world (including USA). Most of the countries are posting negative returns. Canada is holding up well due to strong commodity prices but my guess is that it will fall when the US economic slowdown is certain and the effects of the 'Subprime Virus' works its way throughout the world. Japan--a market closely watched by me--is holding up well due to strengthening of the Yen.

Historically all the world's stock markets have been influenced by each other (except for small and/or obscure, undeveloped, countries). I think when all is said and done, the world will be no different now than it has been for the last century. Decoupling theory seems premature...

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2 Response to Decoupling Theory Weakening

March 4, 2008 at 5:00 AM

As far as I know the decoupling theory was never about the short-term performance of financial markets. The hedge funds, leveraged speculators, who are in trouble own things all over the world. During the crisis they will be selling everything.

The decoupling theory referred to the fact that the economies would decouple first; we would begin to realize that China is fine without the US, they already export more the Eurozone than the US, and that the US economy and market will be mired in problems while the rest of the world goes on with their economic lives. Once this starts to become clears, only then the financial markets will become "decoupled" or have a much lower correlation.

I think that Japan would be a fair comparison.

March 4, 2008 at 9:41 AM

You are correct in saying that it is about economics. But why would the equity markets sell off if they didn't see some clouds on the economic horizon? Why would, say, stocks in Hong Kong, who derive most of their profits from the surrounding area, sell off sharply?

I agree wtih your comment that looking at short-term market movements may be misleading but I feel that this is an early indication that decoupling is likely false. However, we need to wait much longer and see what happens.

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