Emerging markets were written off last year, but they’re quietly putting up more-than-solid returns in 2014.
Indeed, the most popular broad bet on emerging markets — the iShares MSCI Emerging Markets exchange-traded fund (EEM) — is back to levels last seen in the spring 2013.
And destroying benchmark indices all over the developed world.
There were plenty of fundamental macroeconomic reasons for the selloff in emerging markets last year. It’s not like the cornerstone emerging markets of Brazil, Russia, India and China (the BRICs) weren’t loaded with problems and risks. (In fact, they still are.)
But the spark for the explosive selloff in emerging markets was the Federal Reserve telegraphing and then implementing its unwinding of quantitative easing.
The expected rise in U.S. interest rates suddenly made higher-yielding emerging-market assets a lot less appealing or competitive on a risk-adjusted basis.
That was the thinking, anyway, and investors rushed to reallocate their holdings back home.
You know the rest: The S&P 500 went on to rise 30% last year, while EEM cratered. It fell as much as 17% at one point in 2013, rebounded to a degree, but still closed the year with a loss of nearly 6%.
By the time the fire was out, U.S. stocks outperformed EEM by a whopping 36 percentage points on a price basis alone.
Emerging Markets: Whatever Happened to Rising Rates?
A funny thing happened on the way to those higher U.S. interest rates, however. They didn’t materialize. Weak economic growth and low inflation expectations have kept them more than in check.
Just look at the yield on the benchmark 10-year Treasury note. It ended 2013 at about 3%. Today it’s sitting below 2.6%.
Whatever their weaknesses, it’s clear that the beating in EEM was overdone. Just look at how the ETF has performed this year — especially vs. some marquee indexes in the world’s biggest economies.
True, with a 5.1% gain for the year-to-date, EEM is trailing the S&P 500 by a bit more than a percentage point, but it’s sure not lagging any of the other big boys so far in 2014:
- Nikkei 225 (Japan): -4.5%
- FTSE 100 (U.K.): -0.2%
- CAC 40 (France): 2.3%
- Dow Jones Industrial Average (U.S.): 2.2%
- DAX (Germany): 2.6%
Whether EEM is a buy now is a tough call. Much of the easy money looks to have been made.
But there’s no question that developed markets — with the exception of Japan — are expensive even as economic growth remains weak. That has international investors desperately seeking better bargains anywhere they can find them.
Don’t be surprised if EEM keeps outpacing at least the big European benchmarks through the rest of the year.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.