iShares MSCI Emerging Markets ETF (EEM) Gets Boost as Rate Hike Fears Diminish

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It’s amazing how one set of nonfarm payroll data can change plans for the Federal Reserve, but that’s exactly what happened. Up until Friday of last week, the CBOE Fed Watch tool was indicating more than a 50% chance of a rate hike in July.

Emerging Markets: EEM ETF Gets Boost as Rate Hike Fears Diminish

Just a few hours later everything changed. After a dismal job report with Nonfarm payrolls growing by 38,000 in May, against an expected 164,000, the probability of a Fed rate hike was pushed far back. And that is great news for emerging markets stocks and more specifically, the iShares MSCI Emerging Markets ETF (EEM).

The idea of a rate hike coming perhaps this July wasn’t sitting well with Emerging Market stocks. Brazil is in a severe recession, China is in a fragile recovery and commodities — a key growth engine for emerging markets — are extremely vulnerable. A Fed rate hike at this stage could have exacerbated all of the problems that are already weighing on emerging markets.

But now, as a rate hike has been kicked further down the road (possibly all the way to December), emerging markets just got a strong tailwind. The EEM ETF, after lagging in performance to benchmarks such as the S&P 500 in the U.S. and the STOXX 600 in Europe, can finally catch up.

EEM ETF Is Well Positioned

Playing catch up may sound easy, but it’s really a rather delicate game of balance — balance between allocating to the battered sectors in emerging markets now that trade is cheap and diversifying to mitigate some of the risk. The EEM ETF does a good job in maintaining that delicate balance.

In terms of sector allocation, 26% of the EEM ETF is allocated to financials. Financials in emerging markets had been brutally hit by the woes in China and fears over a Fed rate hike. The rather significant allocation allows you to get the upside as the stage is set for a rebound.

Among the stocks EEM holds under the category are China Construction Bank traded in Hong Kong and Industrial & Commercial Bank of China traded in Shanghai.

The IT sector has the second biggest allocation, with 22.5% of total assets, including big names such as Baidu Inc (ADR) (BIDU) and Samsung (SSNLF) stock traded in South Korea.

Consumer discretionary, which is comprised primarily of retailers and deemed risky, is only 11% of the total allocation. Clearly, EEM has the upside on financials and IT, but beyond that, no sector is overly allocated and the risk is mitigated with proper diversification.

When it comes to country risk, the EEM is diversified across the globe into countries such as China, Brazil, India and Taiwan.

The EEM ETF total mix of allocation gives it a weighted PE ratio of 11X, and that is compared to roughly 17X of the SPDR S&P 500 ETF (SPY), which tracks the S&P 500. And that’s not only cheap but also means there’s still plenty of room to go higher without turning expensive.

EEM ETF
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Comparing the EEM ETF with the S&P 500 through the Morningstar Chart, it is clear both have diverged since around 2014, when troubles for emerging markets began. The S&P 500 has a total return of 12% on a rolling basis and the EEM ETF total return is -5%, a 17% gap.

Sure, troubles are not over for emerging markets and they are inherently riskier. But even if the EEM ETF can’t close the gap with the S&P 500 entirely, just meeting the gap halfway it is roughly 8% to 9% upside — worth the risk, despite all the trouble.

As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2016/06/eem-etf-emerging-markets-boost/.

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