Below I present three charts the first is the five year performance of five key ETFs SPY(US), EWZ(Brazil), EWH(Hong Kong), EEM(Emerging Markets), FXI(Shanghai Composite). The second is a specific chart of the ratio of EWZ (prices) divided by EEM (prices). The third chart is a correlation matrix between these assets one a longer dated correlation matrix the second over one year. Note the extremely high correlations between EWZ and EEM. The correlations are applied to 2 month cumulative returns as opposed to intra-day to highlight the relation-ship. Also observe that that in the second chart that correlation can hit some fairly extreme values it is at those extremes that potential trading opportunities exist to either set up a long only position or a relative value pairs trade between the etfs EWZ vs EEM. Note that when correlation falls apart and the ratio of EWZ to EEM prices falls below 1.2 this signifies good entry points to purchase EWZ.
It is also significant that while there is fairly high correlation between all these ETF's that EWZ has by far outperformed the other ETFs. Brazil has the commodities that other emerging markets require to fuel there industrialization and this can help explain the outperformance. Right now the ratio of EWZ to EEM is around 1.6 and correlation is hovering close to 1 extremely high. At this juncture I would adopt a neutral position and await a better entry point when correlation once more breaks down.
