The drumbeat of negative news continues to hit Emerging Markets. By now you know the story: slower growth, higher inflation, higher interest rates, depreciating currencies, political instability, civil unrest, and so on.
In recent weeks, however, an interesting development has occurred. Emerging Market stocks (EEM) have not only stopped going down amid this negative news flow, they are actually starting to move up. And over the past five trading days, they’ve been moving higher while U.S. small caps (IWM) have been moving lower (see chart below).
This is the first time in the history of these ETFs that this extreme divergent behavior has occurred. It is also notable here as you have the most loved asset class in the world in U.S. small caps moving sharply lower while the most hated asset class in the world in Emerging Markets is moving sharply higher.
Still, the negativity on Emerging Markets remains. The most recent Bank of America-Merrill Lynch showed a record underweight among asset allocators to Emerging Markets. It is by far the largest underweight of any asset class in their surveys. This is also consistent with record outflows in Emerging Market equity funds this year, as investors have collectively given up on the asset class.
In looking at a chart of the BRIC ETFs (EWZ, ERUS, INP, FXI) vs. U.S. small caps over the past three years, it is easy to see why. While U.S. small caps are up over 46% in the past three years, all of the BRIC ETFs are down, anywhere from 13% to 37% (see chart below).
This wide disparity in performance has left Emerging Markets significantly cheaper on a valuation basis and the most contrarian investment in the world on a sentiment basis.
But what about that ongoing crisis?
As I have written over the past month in pieces about Russia, India, and China, historically the best time to invest is during a crisis because it is during such times that valuations overshoot to the downside. While it may be psychologically difficult to hear in the short run, as a long-term investor you should be welcoming crisis talk in Emerging Markets as it is precisely this negative backdrop that can lead to a substantial move to the upside.
A “wall of worry” has always persisted in the early stages of any great trade, and there is no higher wall today than in Emerging Markets.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
