The fall in emerging markets has claimed a UK victim – mining shares. Since late January the FTSE mining sector has fallen almost 10 per cent despite the benefit of a weaker pound against the US dollar because it has been dragged down by a 20 per cent drop in emerging markets since then.
This is entirely normal. As my chart shows, miners and emerging markets have been highly correlated for years. Falls in one are usually accompanied by falls in the other.
One reason for this is simply that both are driven by sentiment and appetite for risk. Both have high and similar betas with respect to the All-Share index. Also, both are global cyclical investments; optimism about global economic growth drives both up, and pessimism drives both down.
Investors in both have a problem now. Two separate indicators point to them both falling even further.
One is momentum. Because emerging markets and mining stocks are both especially sensitive to investors’ sentiment, both are prone to momentum. This is because rather than rely only upon their own private valuations of the companies when deciding whether to buy or sell, investors take their cues from what others are doing. This is why both tend to fall and rise so much – to overreact on both the upside and downside. And momentum now tells us to sell both. Mebane Faber at Cambria Investment Management has proposed a simple but effective rule here. We should, he said, buy when prices are above their 10-month (or 200-day) moving average and sell when prices are below it. This rule has worked wonderfully well in the past for both miners and emerging markets, because it would have protected us from long and deep bear markets. It is now telling us to sell both.
Even if you don’t believe this rule (despite the strong evidence for it) the mere fact that others might do so should make you wary of both assets. As the old saying goes, 'never try to catch a falling knife'.
Our second indicator is the annual growth in the M1 measure of the money stock in China. This has in the past been a lead indicator of the country’s industrial production growth and hence of its demand for commodities and therefore of commodity prices. This growth has slowed down in recent months, which points to weak commodity prices, mining stocks and emerging markets shares.
In fact, there’s another reason for caution. Quite simply, both are prone to big losses. In the last 21 years there have been four occasions when both fell more than 20 per cent at the same time: 1997-98, 2002-03, 2007-09 and 2015-16. This warns us to be very careful about buying on dips: those dips can be long and deep.
Of course, the very volatility of both miners and emerging markets make them difficult to predict. And certainly, the 10-month rule ensures that we’d miss out on the early stages of any bounceback. But both history and the few useful lead indicators we have warn us not to chase dips.
My point here, however, is not just about futurology. It’s about risk. To many investors, miners and emerging markets seem like different asset classes – and many of you own lots of both. This, however, might well be riskier than it seems because the hard numbers tell us that both can fall a lot and at the same time. Sometimes, investors need statistics.
