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EM ETFs Rebound in July: Value Trap or Value Play?

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July has been great for emerging market ETFs. The double whammy of a hawkish Fed and trade war fears between the United States and China plagued emerging market (EM) investing in the second quarter.  But the space rebounded to start the third quarter with iShares MSCI Emerging Markets ETF (EEM - Free Report) gaining about 4% past month (as of Jul 30, 2018).

What Led to the Relief?

The main cause of the EM pain in the first half was the dollar rally, which is why emerging markets witnessed the “worst start to a year since the 2013 taper tantrum.” As talks of faster-than-expected Fed rate hikes started doing rounds, U.S. Treasury yields moved higher and the greenback gained strength and EM ETFs fell flat (read: Top ETF Events of 1H to Watch in 2H).

But the greenback has been subdued in July. Invesco DB US Dollar Bullish (UUP - Free Report) lost about 0.5% past month (as of Jul 30, 2018). As a result, emerging market currencies recovered some strength. WisdomTree Emerging Currency Strategy ETF (CEW - Free Report) added about 1.6% in the past month.

Moreover, a sharp selloff in the second quarter made the valuation cheap for the EM bloc. Overall, emerging-country debt has probably seen the best month since March and stocks have witnessed the best month since January, per Bloomberg. Carry-trade investors have enjoyed “their first positive return in four months.”

There are some country-specific developments too. Mexico’s key equity gauge rose to a six-month high, supported by solid corporate earnings and the currency peso strengthened to its strongest level in more than three months in late July. Renewed talks of renegotiating the North American Free Trade Agreement (NAFTA) helped the market.

Is It a Value Play or Value Trap?

Along with several houses like Fidelity International and Amundi Asset Management., we too believe that the recent uptick may prove to be short-lived. The operating backdrop that caused a bloodbath in EM ETFs in the second quarter has hardly changed.

A U.S. GDP expansion of as high as 4.1% in Q2 will only call for a hawkish Fed, which in turn will result in higher treasury yields and stronger greenback. Meanwhile, the ECB is also on its way to end QE this year and the BoJ also tweaked its policy a little toward tightening. All these mean gradual ceases of easy money inflows.

Plus, there is U.S.-China trade war, which has not shown any signs of abating yet. A full-fledged trade war could cut back global growth and hurt EM stocks and ETFs. A client portfolio manager at JPMorgan Chase & Co.’s asset management unit noted that “we might see another correction between now and October,” as quoted on Bloomberg.

Political tensions in countries like Argentina, Turkey and South Africa are the other causes of concern. These economies are victims of volatile currencies and large current-account deficits, per analysts (read: Top & Flop ETF Areas of Q2).

ETF Winners of July

Still, below we highlight some of the winning emerging market ETFs from the month of July (read: 5 Broad EM ETFs That Lost the Least in Q2).

iShares MSCI Brazil Capped ETF (EWZ - Free Report) – Up 14.70%

iShares MSCI Poland ETF (EPOL - Free Report) – Up 12.49%

iShares Latin American 40 ETF (ILF - Free Report) – Up 15.39%

Invesco Emerging Markets Infrastructure ETF (PXR - Free Report) – Up 7.70%

iShares MSCI South Africa ETF (EZA - Free Report) – Up 5.11%

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