Emerging markets are in an interesting place right now. Rising inflation is putting a damper on consumer spending and lower spending is hurting equities. But raising interest rates may not be very viable. Turmoil in the U.S., E.U. and developed countries could spark a slowdown in their economies. This would be only compounded if interest rates were increased.
These factors have combined to create two key opportunities for emerging market investors: Lower consumer spending has caused many consumers to flock to safe havens like consumer staples; and the underperformance of equities has created an opportunity in emerging market debt.
Consumer Staples vs. Discretionary Spending
Rising inflation will force many consumers to switch their spending from discretionary goods to consumer staples. The best way to take advantage of this switch may be a pairs trade in which traders go long consumer staples and short discretionary goods. The profit is realized on the difference, while the moves are isolated from any macro moves.
While international consumer staples companies like Procter & Gamble (PG), Colgate-Palmolive (CL) and Kroger (KR) offer some exposure, ETFs may be the best bet for a diversified selection that isn’t as exposed to the United States market. Investors can also consider purchasing call and put options on the ETFs in order to leverage their exposure and reduce their investment.
Here are some consumer staples ETFs to go long:
- Emerging Global Shares Emerging Markets Consumer (ECON)
- iShares S&P Global Consumer Staples Sector Index Fund (KXI)
- SPDR Consumer Staples Select Sector Fund (XLP)
Here are some consumer discretionary ETFs to short:
- iShares S&P Global Consumer Discretionary Index Fund (RXI)
- SPDR S&P International Consumer Discretionary Sector ETF (IPD)
- iShares MSCI ACWI ex-US Consumer Discretionary Sector Index Fund (AXDI)
Emerging Market Equity vs. Emerging Market Debt
Lower consumer spending will hurt emerging market equities. At the same time, the inability to lower interest rates and avoid a slowdown may curb the ability to stave off recessions. Combined, these factors will likely force a move from equities to safe haven debt. Using a pairs trade, traders can profit from the difference between these two asset classes without taking on significant market risk.
Here are some emerging markets debt ETFs to go long:
- WisdomTree Emerging Markets Local Debt Fund (ELD)
- PowerShares Emerging Markets Sovereign Debt Portfolio (PCY)
- iShares JP Morgan USD Emerging Markets Bond Fund (EMB)
Here are some emerging markets equity ETFs to short:
- MSCI Emerging Markets ETF (VWO)
- iShares MSCI Emerging Markets Index Fund (EEM)
- SPDR S&P Emerging Markets Small Cap ETF (EWX)
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.