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Are Emerging Market ETFs in Trouble?

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After a solid rally in the second half of last year, the emerging markets stocks hit brakes in the recent weeks due to inflationary pressures and the resultant surge in U.S. yields. The MSCI emerging-markets index has lost about 10% from a record high in February (read: ETFs to Win/Lose If U.S. 10-Year Yield Shoots Up to 2%).

The faster COVID-19 vaccine rollouts as well as increased stimulus measures spurred the bets for speedy economic recovery from a coronavirus-induced slump, leading to spike in inflation. Many developing nations are struggling, as they need to fund increased spending to revive their pandemic-battered economies with the rise in borrowing costs.

Additionally, the wave of tightening policies in nations like Brazil, Turkey and Russia this month has added to the chaos. Brazil’s central bank raised interest rate for the first time in nearly six years by 75 basis points (bps) and has expressed its intention of a similar increase in May to fight inflation. Brazil’s inflation is currently 5.2%, well above the central bank’s year-end target of 3.75%. Turkey raised its one-week repo rate to 19% from 17% to combat inflationary pressures triggered by oil price surge and depreciation of lira against the U.S. dollar (read: U.S. Dollar to Strengthen? ETFs to Gain/Lose).

Further, Russia surprised with rate hike for the first time since 2018. The central bank lifted rates by 25 bps to 4.5%, with a signal to increase the same to 5.5% by the end of the year. Food prices in Russia have shot up, adding to a decline in living standards during the pandemic.

The surging U.S. yields would pull out more capital from these markets, stirring up trouble for most emerging nations.

Emerging Market ETFs Depressed

Most of the emerging market ETFs saw terrible trading over the past month, pushing many of these into the red on a year-to-date basis. Emerging Markets Internet & Ecommerce ETF (EMQQ - Free Report) stole the show, plunging about 16% in a month. This was followed by declines of 13.9% for KraneShares Emerging Markets Consumer Technology ETF (KEMQ - Free Report) and 12.2% for Invesco S&P Emerging Markets Momentum ETF (EEMO - Free Report) .

Coming to specific country look, iShares MSCI Turkey ETF (TUR - Free Report) and VanEck Vectors Egypt Index ETF (EGPT - Free Report) have shed 15.6% and 10.4%, respectively, over the past month.

What Lies Ahead?

Despite the recent slide, emerging markets look attractive thanks to improving economic growth in a number of the developing countries, a pickup in manufacturing activity, rise in commodity prices, better current accounts, better-than-expected earnings and growth policies (read: Time for Emerging Market ETFs?).

Additionally, emerging markets appear attractive at current levels after being beaten down badly amid the pandemic. Notably, the ultra-popular Vanguard FTSE Emerging Markets ETF (VWO - Free Report) has a P/E ratio of 19.2 versus that of 22.1 for SPDR S&P 500 ETF (SPY - Free Report) .

Additionally, the accommodative policy of the Fed will support the emerging market equities as it will keep the greenback at check. The Fed has pledged to keep interest rates near zero with no interest rate hikes through 2023. It will continue to buy $120 billion in Treasury and mortgage-backed securities per month. However, the central bank projects a rapid jump in U.S. economic growth and inflation this year as the COVID-19 crisis winds down. Continued rise in inflation could again be a worry for the space but it is a sign of strengthening domestic economy that could lead to higher demand and benefit emerging market exporters (see: all the Broad Emerging Market ETFs here).
Given the strong long-term outlook but somewhat bearish near-term sentiments, investors may want to consider staying on the sidelines for the time being. However, risk-tolerant, long-term investors may want to consider this recent slump a buying opportunity, should they have the patience for extreme volatility.

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