Should You Remain Diversified or Should You Abandon Emerging Market ETFs?

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 |  Includes: BRF, DIA, EPI, FRN, GXC, IDX, IYJ, IYM, IYW, KBE, QQQ, VDE, VWO
by: Gary Gordon

The media remain hell-bent on describing U.S. economic acceleration, Dow 12000 and marginal labor market improvements. The analysts seem equally giddy, reiterating quotable notables like “Don’t fight the Fed!” or “Don’t fight the tape!”

I agree that there are reasons to be hopeful. We’ve been privy to robust corporate earnings as well as strong corporate balance sheets, share buybacks and a variety of key acquisitions. Yet I don’t agree that investors can disregard the impact of world central bank policy. I certainly don’t think that we can cast aside the tale of the emerging market tape.

At the present moment, it may seem to some as though developed world stocks have decoupled from developing world equities. The last three months have been dreamy for high-beta U.S. Sector ETFs, but nightmarish for 3/4 of the BRIC emergers (i.e., Brazil, India and China.)

It Was The Best Of Times…
Approx 3-Month %
Vanguard Energy (NYSEARCA:VDE) 25.3%
SPDR KBW Bank (NYSEARCA:KBE) 19.7%
iShares DJ Industrials (NYSEARCA:IYJ) 15.2%
iShares Basic Materials (NYSEARCA:IYM) 14.6%
iShares DJ Technology (NYSEARCA:IYW) 9.6%
PowerShares Nasdaq 100 (QQQQ) 8.1%
Dow Jones 30 Diamonds Trust (NYSEARCA:DIA) 8.1%
It Was The Worst Of Times?
SPDR S&P China (NYSEARCA:GXC) -5.2%
Claymore BNY Frontier Markets (NYSEARCA:FRN) -7.2%
Market Vectors Small Cap Brazil (NYSEARCA:BRF) -9.0%
Market Vectors Indonesia (NYSEARCA:IDX) -9.8%
WisdomTree India Earnings (NYSEARCA:EPI) -17.3%
Click to enlarge

With discrepancies as wide as these, should we be surprised by the net outflow of money from emerging market equities in January? Probably not.

Of course, there’s a natural tendency for investors to take profits on their biggest winners in January, and emerging markets were 2010’s biggest winners. There’s also a reality that many emerging countries are battling inflation through restrictive monetary policy, which in turn should decelerate economic growth.

Yet the only thing that matters to investors is should they stay the course with a diversified stock mix of emergers, developed world foreign stocks and U.S. stocks? Or is time to abandon ship? The answer is ... neither.

You have to think in terms of maintaining a diversified mix of stocks and a diversified mix of income producers ... to the extent that it remains sensible. However, you shouldn’t expect to achieve superior results through buying-holding-and forgetting, nor should you sell everything that underperforms.

For example, let’s say that you read the Economist’s story last October, “How India Will Outpace China.” And let’s say that the info inspired you to buy shares of WisdomTree India (EPI). You may have acquired your shares at a price of 28.0 while the ETF was still above its 200-day trendline. Yet a reasonable stop-limit loss order at 25 could have acted as your protection against further deterioration; or, perhaps a sell order when EPI dropped below the 200-day (24.5) could have acted as your guide. If you didn’t have an exit strategy, however, you’d still be holding a fund that is now down -18.2% from your purchase point ... and you’d have no idea what to do next. (Talk about an emotional quagmire!)

Pruning for protective purchases is sensible. It is how you avoid the bulk of any disaster, including the way that many investors minimized the risks of 2008’s systemic collapse.

By the same token, though, you don’t sell all of your positions because they’re “underachieving.” Vanguard Emerging Markets (NYSEARCA:VWO) may be treading water since it surpassed 48 in November, 2010, and again in January, 2011. That said, it has neither dropped 10%-12% from its peak, nor has it fallen below its 200-day trendline. The longer-term uptrend should give you the conviction to hold onto your broad-based emerging market ETF, even though it isn’t currently rockin-n-rollin like the Dow or the NASDAQ.

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.