From Zacks: Emerging market (EM) ETFs had a decent run in the last one year (as of January 4, 2016) with iShares MSCI Emerging Markets (EEM – Free Report) returning about 16%. Accommodative developed market central banks, which have kept interest rates low for long, bolstered demand for higher-yielding emerging market securities.
The growth picture of EM equities is brighter than that of the developed markets. If this is not enough, many emerging markets like Indonesia and India cut interest rates to boost growth amid lower inflation. Also, a boom in commodities benefited several commodity-rich emerging markets in 2016.
However, things are expected to turn sour this year as the Fed enacted its second rate hike in about a decade in December 2016 and intends to ratify three more in 2017. This along with an improving U.S. economy pushed the greenback to a 14-year high forming clouds over the skies of EM investing as this can widen some emerging markets’ current account deficit (read: Sole Fed Hike of 2016 Put These ETFs in Focus).
Reasons for EM ETFs’ Likely Outperformance in 2017
But investors should note that several analysts are bullish on EM ETFs in 2017. EM looks less perturbed by Brexit. Trade relations between the U.K. and the broad-based emerging market are meager, thus posing no-to-little threat to emerging market investing (read: Bremain or Brexit: No Worries for EM ETF Investing).
As per Deutsche Bank, the correlation between EM performance and the benchmark U.S. Treasury yields since 2010 has been positive except for 2013, when taper talks weighed heavily on emerging market securities. In 2013, the correlation between EM equities and the U.S. 10-year yield was negative 69%. But if we strip out that period, the correlation turns out to be positive 74% (read: 6 Bond ETFs to Play Higher Rates).
EMs boast cheaper valuation. As per an article published on Forbes, iShares MSCI Emerging Markets index has a P/B ratio (ttm) of 1.38 times, lower than iShares MSCI EAFE’s 1.48 times and S&P 500-based ETF SPY’s 2.71 times. P/E (ttm) of EMs also came below the other two indices, while the 5-year projected EPS growth was 9.58% for EMs, 7.96% for iShares MSCI EAFE and 8.6% for SPY.
To boost growth, several emerging economies have been resorting to policy easing via interest rate cuts or some other accommodative measures. Among the pack, India, Brazil, Russia and Indonesia deserve a mention. Many emerging economies are enacting pro-growth reforms now. So, higher growth rates should offer investors both capital gains and solid yields (read: Brazil ETFs in Focus as Central Bank Cuts Rates Again).
The Chinese economy – the largest emerging market – has been gaining momentum lately. China’s service sector activity jumped to a 17-month high in December while the China Caixin manufacturing Purchasing Managers’ Index marked the three-year best improvement in December.
4 EM ETFs Off to a Good Start to 2017
Below we highlight a few ETFs that have seen a decent start to 2017 and may continue to taste success in the near term.
The fund looks to track an index which picks large-cap stocks based on four fundamental factors: book value, cash flow, sales and dividends. Financials (30.4%) and Energy (25.3%) are the top two sectors of the fund while Brazil (28.8%), China (21.4%) and Russia (11.3%0 are the top three geographical regions. The fund charges 49 bps in fees.
As per Credit Suisse, EMs are likely to benefit from “growing middle-class incomes, flexible Gross Domestic Product (GDP) growth prospects, as well as very young populations as a base for consumption.” South Africa (22.5%), China (21.2%) and India (13.5%) are the top three regions, while consumer discretionary (54.2%) and staples (43.3%) are the top two sectors. The fund charges 85 bps in fees.
This fund also measures the performance of companies in emerging markets that are tied to domestic demand. China (26.8%), South Africa (19.4%), India (14.6%) and Mexico (12.2%) are the top four countries while discretionary, staples and telecom are the top three sectors of the fund. The 50-stock fund charges 65 bps in fees.
The fund gives exposure to EM stocks with high dividend yields. It yields about 4.94% annually while charging 49 bps in fees.
iShares MSCI Emerging Markets Indx (ETF) (NYSE:EEM) closed at $35.94 on Friday, down $-0.15 (-0.42%). Year-to-date, EEM has gained 2.66%, versus a 1.65% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of Zacks Research.