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The Fed did emerging markets and the TSX a favour

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The S&P/TSX Composite continues to act like an emerging markets index, placing Canadian investors among the biggest beneficiaries of the Fed's "now you see it, now you don't" taper caper.

The correlation between the MSCI Emerging Markets (EM) Index (U.S. dollar) and the S&P/TSX Composite remains insanely high (r-squared is 0.72) and this has been the case for the past decade. I made a big deal out of the divergence that started in June, when the domestic equity benchmark remained stable despite a sharp decline in the EM index.

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This divergence is now being corrected in a positive way for domestic investors – EM equities are rebounding sharply. The result, for now, is that the TSX no longer looks like it's defying gravity relative to EM.

Chairman Ben Bernanke's head fake Wednesday should help this trend along. The prospect of reduced Fed monetary stimulus caused a mass exodus of investment assets out of EM, depressing equity, bond and currency prices. Now that tapering is delayed, EM assets have a clearer path higher.

As this chart shows, a rising MSCI Emerging Markets index is a very positive indicator for Canadian equities.

The sustainability of this positive market backdrop is difficult to judge. It's possible we'll just have to go through the same exercise – wondering whether to adjust to Canadian stock prices to weaker EM equity markets – ahead of the next Fed meeting. Interest rates are still elevated (relative to the beginning of the year) across the globe and this will have a negative effect on future growth.

But in the short term, things look pretty good for Canadian investors. Emerging markets are recovering from the taper shock, materials prices are rallying as China reopens the credit spigots, interest rates have stabilized and the doomsayers on the domestic housing market have quietened.

We'll see how long it lasts.

Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights , and follow Scott on Twitter at @SBarlow_ROB .

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