Are Emerging Markets ETFs Safer than Their Developed Markets Cousins?

Includes: EEM, XLF
by: Gary Gordon

Gail Marks Jarvis of the Chicago Tribune explains that risk is sexy once again. After all, iShares MSCI Emerging Markets (NYSEARCA:EEM) is up 55% from the March lows compared to 35% for developed markets in the U.S. and Europe.

Yet it may be time to redefine what is risky. For example, it wasn't that long ago when a conservative investor may have sought dividend yield from safe financial stocks. Today, most investors won't touch the Financials Select SPDR (NYSEARCA:XLF) with Captain Ahab's fishing pole.

Just how risky have financial stocks been? For all of the talk about EEM rising 55% off its March lows, XLF has catapulted more than 100%. Moreover, the daily price range for XLF has approximated 7% in 2009, close to double the daily price range of iShares MSCI Emerging Markets (EEM).

You can see similar price volatility differences by looking at the weekly closing prices of XLF and EEM. (Which line looks more erratic/volatile/risky to you?)

Xlf versus eem

Remember, the Financials Select SPDR (XLF) represents banks, diversified financials and insurance companies... boring old insurance companies... of the United States. One of the safest economic segments in the most reliable economy in the world, right?

Simply stated, things change.

Consider additional changes that have been coming down the pike. California, the world's 7th largest economy on its own, faces a $21 billion budget deficit shortfall and its bonds are "junk." Meanwhile, ratings agency Standard & Poor's lowered its outlook on Britain to negative on Thursday. While Standard & Poor's "reaffirmed" Britain's 'AAA' long-term credit status, the mere fact that the country's long-term credit is in doubt means old, reliable England is more risky.

Investors may need to recognize, then, that the developed markets may actually be a "riskier" prospect than places like China or Brazil. For instance, China's $600 billion economic stimulus bolsters its middle class spending, infrastructure improvements as well as Chinese purchases from Chile, Brazil and neighboring countries in Southeast Asia. China may go through bulls and bears, but China may just be a safer investment than the U.S. (I'm biting my tongue!)

Developed markets are, in fact, making their way out of recession. We see that in the Leading U.S. Economic Indicators first upbeat reading in 7 months. We see it the Philly Fed's Manufacturing Survey that showed overall manufacturing declines, but significant improvements between March and April. We see it in a "less horrible" construction spending report out of Europe, where an 8.6 percent spending decline isn't quite as disastrous as the expected 11% cliff dive.

However, just because the developed markets are working their way towards stability, the case for high-flying expansion isn't on anyone's radar. Rather, a more stable developed world simply means that developed countries may continue to buy goods from... yep, the emerging market regions.

So how should we really calibrate risk? Should we look to the past, viewing the developing world as a source of untold uncertainty? Or do we look to the future, and consider the possibility that the largest countries in Japan, the U.S. and western Europe may have more to lose? After all, it's Britain that's in danger of losing its credit rating and it's the U.S. dollar back at 5-month lows.

Full Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company may hold positions in the ETFs, mutual funds and/or index funds mentioned above.