Best ETFs for 2018: This Isn’t the Year for Emerging Markets (DVYE)

DVYE - Best ETFs for 2018: This Isn’t the Year for Emerging Markets (DVYE)

This article is a part of InvestorPlace’s Best ETFs for 2018 contest. Charles Sizemore’s pick for the contest is the iShares Emerging Markets Dividend ETF (NYSEARCA:DVYE).

Well, I should probably start this by mentioning that I no longer personally own the ETF I recommended in InvestorPlace’s Best ETFs for 2018 contest.

I recently sold my shares of the iShares Emerging Markets Dividend ETF (NYSEARCA:DVYE). While I still believe that emerging markets are likely to be one of the best-performing asset classes of the next ten years, it’s a minefield in the short-term. As I write this, the shares are down 5% on the year. That’s not a disaster by any stretch, but it is a disappointment.

There are a couple reasons for the recent underperformance in emerging markets. To start, the U.S. market remains the casino of choice for most investors right now. Adding to this is dollar strength. While dollar strength is good for countries that sell manufactured products to the United States, it’s bad for commodities producers, as a more expensive dollar by definition means cheaper commodities.

President Donald Trump’s trade war isn’t helping either. While it’s hard to argue that anyone truly “wins” a trade war, Trump isn’t incorrect when it says that our trading partners need us more than we need them. In a war of attrition like this, you “win” by losing less.

Of course, these conditions are not new, and virtually all of them were in place when I made the initial recommendation of DVYE. None of these factors would be enough for me to punt on emerging markets just yet. No, the problem is a greater risk that has only recently popped up: the twin meltdowns in Argentina and Turkey.

Troubles for DVYE

I’ll start with Argentina. It seems that poor Argentina is “due” for a good, old-fashioned financial crisis about once every decade. But what is frustrating today is that Argentine President Mauricio Macri has been following sensible policies that have, by and large, met the approval of the International Monetary Fund and the financial community. Alas, it’s too little too late, and he’s paying the price for the excesses of his populist predecessors.

Argentine Pesos per US Dollar

The value of the Argentine peso has been cut in half since May. Then, a dollar would cost you 20 pesos. Today, its 40 … and climbing.

The plummet in the peso is driven, in part, by high inflation. Argentina is fighting both the plunging currency and the soaring inflation rates by hiking short-term interest rates. But this is pushing an already fragile economy closer to official recession territory.

Macri tried to get ahead of the crisis by proactively asking the IMF for loan. He figured it made sense to ask early rather than wait for the crisis to get out of hand. Yet it had the opposite effect, further eroding confidence.

Making it all worse, Macri has to navigate all of this while preparing for a presidential election next year. And stemming the crisis might mean taking measure that are unpopular… which risks putting the populists that created this mess back in power.

The problem isn’t Argentina, per se. It’s what happens next. If investors continue to flee Argentina, might they proactively decide to flee Brazil too? Brazil is dealing with a milder political meltdown of its own, and investments might decide that the entire region is best avoided for now. This is what we call contagion, and it’s a recurring problem in emerging markets.

Meanwhile, Turkey is also looking like a total basket case.

Turkish Lira per US Dollar

The Turkish lira has lost about a third of its value relative to the dollar since April. But here, the plot is significantly more complicated. The Turkish central bank just hiked interest rates to try and contain the run on the currency. They raised the benchmark rate from 17.75% to 24%.

That’s a standard move. The problem is that it contradicted orders from Turkey’s authoritarian president Recep Tayyip Erdogan to lower rates. No one knows what happens next. Will Erdogan let it go? Or will he rip away the fig leaf of central bank independence and reverse the policy? No one knows.

It is entirely possible (maybe even likely) that Argentina and Turkey stabilize from here and that the would-be emerging market crisis of 2018 ends up being a false alarm. I consider this the most likely scenario.

But if this slides into full-blown crisis, I don’t want to be left holding the bag. So for now, I’m stepping away from DVYE. If my larger bullish thesis is correct, and emerging markets enjoy multiple years of strong outperformance, there will still be plenty of time to jump back in later.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas.

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