Emerging Market ETFs: Price Ratios And The Reflation Trade's Revival

Includes: EEM, VWO
by: Gary Gordon

Back in 2009, a flood of easy money worldwide sparked super-sized gains for the emerging markets, more so than their developed world counterparts. Granted, stock assets for industrialized and developing regions were both remarkable. Yet the best investment profits involved commodities, materials and rapid-fire economies with the most “stuff.”

By mid-2010, the industrializing world found itself tightening fiscal and monetary policies to curtail runaway prices. Toss in the eurozone’s sovereign debt crisis, and it wasn’t long before investors began to abandon resource-rich Asia, Latin America, the Middle East and Africa. In contrast, the Fed’s additional quantitative easing measures (QE2 and QE 2 1/2) continued to support U.S. equities in 2010 and 2011. In other words, while the U.S. was reflating assets to battle perceived deflation, the industrializing economies were letting the air out to fight inflation.

Is it possible, though, that we’ll see a revival of the global “reflation trade?” More specifically, Europe, Great Britain and even China will find themselves needing to be more accommodative with interest rates and bank reserves. In fact, it may be the only way for Europe to minimize the duration of economic contraction and the only way China can secure the proverbial soft economic landing.

If nothing else, the markets themselves are forward-looking creatures. Consider the price ratio of Vanguard Emerging Markets (NYSEARCA:VWO) relative to the S&P 500 SPDR Trust (NYSEARCA:SPY) below. The price ratio has risen off of 52-week lows, which means that emergers are outperforming here in 2012. Moreover, VWO:SPY has not been this close to a key 200-day trendline in nearly six months. (Note: VWO:SPY hasn’t risen substantially above its long-term trendline in more than a year.)

Click to enlarge

VWO-SPY Price RatioClick to enlarge

In truth, I’m not completely sold on the notion that we’re going to get the kind of asset reflation that we witnessed in 2009. For one thing, I would indeed need to see VWO:SPY climb convincingly above its 200-day moving average. I’d also need to see a continuation of declining three-month LIBOR rates. While the near-term LIBOR trend is very encouraging, we can’t know for certain that European banks are genuinely ready to lend to one another freely until the rate falls below - and stays below - a key intermediate-term moving average (100-day MA).

LIBOR3 100-DayClick to enlarge

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.