Are Emerging Market ETFs Raising a Red Flag?

January 25th at 6:03am by Tom Lydon

Emerging market stocks and exchange traded funds outperformed the S&P 500 in the fourth quarter of 2012 and investors are chasing with large inflows to developing economy ETFs. However, emerging market funds have been lagging so far in 2013, leading some to worry about the strength of the rally in global equities.

Volatility in emerging market ETFs recently fell to the lowest level in at least a decade but could be poised to rise. Because of their sensitivity to global risks, emerging markets have been known historically for their volatility.  [Emerging Market ETFs See Inflows as Volatility Lowest Since 2003]

“Emerging market stocks are a great area to watch for a read on global sentiment, given that most EM countries are dependent upon cyclical growth expectations and export demand,” writes Michael A. Gayed, chief investment strategist and co-portfolio manager at Pension Partners, for Seeking Alpha.

During the hype surrounding the so-called fiscal cliff, the emerging markets outperformed the U.S., but the opposite occurred after a deal was reached.

“Clearly investors do not necessarily need emerging market stocks to lead in order for a risk-on environment to take place, but movement coincides with sentiment on cyclical expectations for growth,” Gayed added. “I wonder if this is more of a larger warning that the strong start to risk assets may soon be over.”

For instance, in comparing the iShares MSCI Emerging Markets (NYSEArca: EEM) to the SPDR S&P 500 ETF (NYSEArca: SPY), EEM has been underperforming SPY so far year-to-date.

Start of a trend?

Chart source: Pension Partners

For more information on the emerging markets, visit our emerging markets category.

Max Chen contributed to this article.

Full disclosure: Tom Lydon’s clients own EEM and SPY.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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