Tech Stocks May Be Achilles' Heel of Emerging-Market Rally

(Bloomberg) -- A selloff that seems to grip information-technology stocks every six weeks may prove to be the undoing of the two-year rally in emerging markets.

A 10 percent slump from November to December, a 12 percent slide from January to February and another 10 percent drop from March to April, along with subsequent rebounds, have left an index of developing-nation technology stocks where they were six months ago. As a result, the gauge is nearing a bearish head-and-shoulders pattern that, if fully formed, may signal large-scale declines.

The fate of technology stocks is critical for emerging markets as a whole. The weight of the information-technology subgroup in the $5.5 trillion MSCI Emerging Markets Index has surged over the past decade, with the rise of companies like Alibaba Group Holding Ltd. and Baidu Inc. About 28 percent of the MSCI index is made up of technology stocks, compared with 10 percent in 2007 and 20 percent in 2001.

That means technology is now a bigger influence on emerging-market equity returns than even during the dot-com era.

So to what extent will a technology selloff drag down the broader emerging markets? There are some clues in regression analysis, which reveals the sensitivity of one security to moves in another. Regression is typically studied by comparing a subgroup index with a broader gauge. But here, the study is of the broader market’s sensitivity to fluctuations in the subgroup.

In the past 10 years, for every percentage-point move in information technology stocks, the MSCI emerging-market gauge has moved in the same direction by 0.86 percent. That means a drop in tech shares has a substantial impact on emerging markets as a whole.

The MSCI EM Information Technology Index fell 0.4 percent Thursday, ending a three-day rally.

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