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Should You Buy EM ETFs Despite Trade War & Other Concerns?

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Emerging markets’ (EM) equities had a dream run last year. The rally was prompted by accommodative developed market central banks that kept interest rates low and drove investors toward the relatively high-yielding EM bloc as well as improving global economic fundamentals.

Some of the other drivers of 2017 were a subdued greenback, commodity market strength and policy easing in several EM economies. In fact, EMs are now more insulated to a rising rate environment in the United States, overcoming the jitters that rate hikes gave them earlier.

The popular emerging market ETF iShares MSCI Emerging Markets ETF EEM has added about 20% in the last one year (as of Apr 9, 2018), despite a 1.8% decline in the year-to-date frame (as of Apr 9). However, given the prevailing broader market volatility that has not spared EMs this year, let’s discuss if investors should invest in ETFs on these markets now.

Wall of Worry

Along with the broader market, EM equities have slid this year. Rising rate fears, trade war talks and overvaluation concerns after a steep rally last year actually planted suspicion in investors’ mind.

Fed Policy Tightening

With chances of faster Fed rate hikes ahead given the U.S. central bank’s upbeat outlook on the American economy, many are foreseeing darker clouds over the skies of EM investing. The common perception is that if the Fed tightens policies, the greenback will regain its lost ground, benchmark U.S. Treasury yields will start rising, which in turn will dull the lure for EM equities (read: 5 ETFs to Profit From Fed Activity & Guidance).

But Treasury yields did not shoot up in recent trading thanks to geopolitical crisis. Plus, EMs are not that fragile today like how they were during taper tantrums in 2013. As per Deutsche Bank, the correlation between EM performance and the benchmark U.S. Treasury yields since 2010 has been positive except for 2013.

Trade War Fear with China

By now the trade tension between China and the United States that started in March is known to all. There has been a chain of retaliations in import tariff announcements by both countries. President Donald Trump intended to “protect the technology and intellectual property of American companies and American people” and engrossed itself in a trade war with China.

However, Trump mentioned that the United States is open to discussions with China. President Donald Trump also said in a tweet on Apr 8 that he expects China to reduce trade barriers and not to respond to U.S. taxes. In short, trade tensions are easing (read: Trade Tensions or Not, Stay Safe with These ETFs).

Sanctions Against Russia

Russia has been condemned internationally over the weekend for supporting the Syrian government which is allegedly responsible for a chemical weapons attack. The U.S. President cautioned that “big price” to be paid by the Syrian regime and its Russian and Iranian ally if allegations about the chemical attack were confirmed. 

The United States already imposed its harshest sanctions to date against Russian oligarchs, officials, businesses and agencies. The sanctions forbid U.S. citizens or entities from doing business with the sanctioned Russian entities. Russian stocks staged the biggest decline since the Crimea standoff in 2014. VanEck Vectors Russia ETF RSX lost about 10.5% on Apr 9. Needless to say, this sparked off concerns about EM investing.

Will EMs Ride the Wall of Worry?

Analyst are of the view that there is nothing to worry about. One analyst kept EM markets over developedones thanks to “better valuations, very light positioning, stronger growth, improving credit fundamentals and, of late, a clear deterioration in economic policy in some developed countries.” Most analysts see the likelihood of trade war as very low (read: 5 Reasons Why Emerging Market ETFs Are Still a Buy).

Moreover, the recent tech selloff has eaten up 8.4% of the MSCI Emerging Markets Index since it peaked on Jan 26 while the S&P 500 has lost 7.3% over that period, as per Wall Street Journal. This indicates somewhat lower overvaluation risks at the current level. EEM still has a low P/E of 14.56x compared with SPDR S&P 500 ETF’s (SPY - Free Report) P/E of18.67x.

Below we highlight a few broader emerging market ETFs that have lower P/E than EEM and a Zacks ETF Rank #3 (Hold).

First Trust Emerging Mrkts AlphaDEX ETF FEM – 10.03x

iShares Emerging Markets Dividend ETF DVYE – 10.04x

First Trust Emerg Mkts SC AlphaDEX ETF FEMS – 10.57x

WisdomTree Emerging Markets Consumer Growth ETF EMCG – 11.10x

Schwab Fundamental Emerging Markets Large Company Index ETF FNDE – 11.76x

WisdomTree Emerging Markets Small Cap Dividend ETF DGS – 13.34x

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