Long the darling of the emerging markets, the fast charging bull of China has suddenly became a critical laggard. After the Dow Jones Shanghai Index jumped an astonishing 62% between January until mid-June of this year, the Chinese markets took a disastrous spill, causing the index to be in the red 7% year-to-date.
As a direct result, emerging markets funds that are heavily levered towards China — in particular, the exchange-traded fund Vanguard Emerging Markets Stock Index Fund (VWO) — suffered a torrent of bearish trading activity.
Although the VWO ETF is near price levels not seen since a mini-crash that occurred in the summer of 2011, there is a fundamental danger that emerging markets are yesterday’s news.
Barclays PLC analysts reiterated a common sentiment, noting the risks associated with deflated commodities, China’s economic slowdown, and the potential of the U.S. Federal Reserve tightening monetary policy. Combined, these factors represent a seemingly impossible hurdle for the emerging markets due to their sensitivity towards global economic shifts.
Nor are the headwinds limited to “paper” manifestations. According to research from Capital Economics, manufacturing output from the emerging markets took a hit in July, with the Purchasing Managers’ Index (PMI) moving down nearly 1% against June to 49.1 In addition, the current PMI level breached a barometer that is used to distinguish between economic expansion or contraction.
VWO ETF Technicals
Despite the rather ominous clouds hanging over the emerging markets, some experts maintain a bullish outlook on tradable funds like the VWO. According to UBS Securities’ analysts, this kind of discrepancy in expected volatility between an emerging markets ETF and the underlying country ETF typically results in upside momentum for the former.
Another technical factor that may specifically buoy optimism for VWO ETF investors is that the VWO has a tendency of bouncing back strongly from large, singular selloffs. For example, whenever the VWO absorbed a one-day loss of 1% or more, the fund averaged returns of 1.3% per month after the selloff. Even more impressive, market returns average 3.5% three-months after the initial drop.
Interestingly, when the VWO ETF is technically within a bear market cycle — when its 50 day moving average is below its 200 DMA — the bounce-back from volatility is even stronger. Down 1% or more, VWO returns 1.7% a month after the hit, and nearly 5% in the following three months.
The long-term statistics do suggest that “buying the dip” in the VWO ETF could be profitable — under normal market conditions. However, on July 27, 2011, the VWO gave up 1.6% in value. Three months later, it was down more than 16%. And who could forget the events leading up to the 2008 financial collapse? On July 18 of that year, the VWO lost a little more than 1%. By late October, the investment was down a tear-jerking 44%.
Overall, the message is clear: The emerging markets and the VWO ETF are usually a good investment, but the fundamentals cannot be ignored without serious consequence.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
