Emerging Market Truths, Frontier Market Truths And ETF Statistics

Includes: SPY, VWO
by: Gary Gordon

China’s manufacturing sector is contracting, Brazil’s consumers are retrenching and India’s economy is growing at the slowest pace in a decade. Is it any wonder that commentators as well as investors are abandoning the concept of “BRIC” (Brazil, Russia, India, China) funds?

Others muse that the real opportunities can be found in different emerging markets or even in the so-called frontier. They have attempted to popularize acronyms like “MIST” (Mexico, Indonesia, South Korea, Turkey) and “CAPT” (Chile, Peru, Philippines, Thailand). However, country ETFs representing the components of MIST and CAPT have crumbled at an alarming pace.

“Alternative” Emergers Faring No Better Than “Mainstream” Emergers
Approx 6 Month
S&P 500 SPDR Trust (NYSEARCA:SPY) 15.0%
iShares MSCI Thailand (NYSEARCA:THD) 1.3%
iShares MSCI Turkey (NYSEARCA:TUR) -2.3%
iShares MSCI Mexico (NYSEARCA:EWW) -7.5%
Vanguard Emerging Markets (NYSEARCA:VWO) -7.9%
Market Vectors Indonesia (NYSEARCA:IDX) -7.9%
iShares MSCI Chile (BATS:ECH) -10.4%
iSharesMSCI South Korea (NYSEARCA:EWY) -11.9%
iShares MSCI Peru (NYSEARCA:EPU) -16.8%

Obviously, any exposure to emerging markets or frontier markets over the last 6 months has dragged on portfolio performance. Even more disconcerting is the reality that broad emerging market exposure has been a drag for 2 1/2 years already.

Perhaps an optimist would find the underachievement of frontier ETFs and/or mainstream emerging market ETFs as a cause for celebration. The price-to-earnings (P/E) discount relative to the U.S. market makes them “cheap.” And… isn’t it darkest before the dawn? Wouldn’t it be bleakest before a re-emergence?

Unfortunately, there hasn’t been widespread panic or capitulation in developing country equities, suggesting that the darkest hour has yet to arrive. Moreover, I am troubled by the 6-month correlation between Vanguard Emerging Markets (VWO) and the S&P 500 SPDR Trust (SPY) at -0.60. Even in the previous decade’s era of “decoupling” — a period when emerging markets doubled or tripled the upside performance of U.S. stocks — it was rare to find any significant span where the asset types failed to exhibit large positive correlations. At this moment, VWO and SPY move in opposite directions more often than not!

I expect the dynamic to change… and soon. Either we’re going to see continued weakness in emerging market stocks such that developed world stocks pull back dramatically, or we’ll see emerging market stocks stage an impressive turnaround. That turnaround would be necessary to assist U.S. stocks in a future rally — one that is not entirely juiced by the Federal Reserve. Yet one way or another, VWO and SPY are not going to maintain a -0.60 correlation for much longer.

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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.