US Stocks: Emerging Markets Set to Rally

Posted On October 17, 2018 2:42 pm

Emerging Market

Source: Shutterstock.com/g/alexskopje

The U.S. stock market has hit a rocky patch over the past two weeks. But the S&P 500 Index still remains less than 5% below all-time highs.

This is a marked contrast from the emerging markets, which have been sliding, and many in bear market territory, for the past few months.

You can see the extreme decoupling that occurred between the S&P and Emerging Market Index (EEM) that began in May.

Emerging Market Index, eem

This of course coincided with the ramping up of trade war and tariff talk. While a resolution between the U.S. and China is still up in the air, many of the satellite players have already absorbed any fall-out and have shored up their sovereign balance sheets.  

EM Economic Health

The markets seem to have discounted this fundamental dispersion. Countries with surpluses have had stable or appreciating currencies this year. Those with deficits have had declining currencies.

It appears that negative sentiment may have even overshot — as emerging markets currencies have sold off by more than debt and equity outflows would generally imply. Notably, in the last week of September, emerging markets bond inflows rose to their highest level, $2 billion, since February’s $483 million.

On the other side of the coin, emerging market equities recorded outflows in nine of the past 10 weeks.  But the pace is decelerating. Trade protectionism remains a real risk although this seems to be fully discounted.

Emerging markets equities now have the lowest valuations of any major asset class, and free cash flow yields are estimated at 5%–7% over the next 12–15 months. Their discount to developed markets has deepened to the 30% range.  

Some markets, most notably Brazil, have already started to turn high. The catalyst for the turn in Brazil is the election where it now seems the right wing, pro-business candidate has a legitimate shot at winning.  Since he closed the gap in polls last months ago the Brazilian market has surged some 30%!

EWZ, MSCI Brazil Index Fund ETF

Rising commodity prices, for which emerging markets tend to be net exporters, will also bolster those markets.

It’s interesting to note Brazil’s main exports — coffee, oil, and soybeans, also jumped in recent weeks.  

Here’s the coffee ETF which is also up some 34% in the past month:

BJO, Barclays PLC

Source: freestockchart.com

All things economic tend towards reversion and it would seem emerging markets are poised to rally, and play catch up to the U.S.


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About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.

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