Emerging v. Developed Markets
Drama around the U.S.–China trade deal, the harsh realities of the Brexit transition, and political dysfunction across continental Europe is leading to speculation on where world economies and markets are headed. Purchasing Manufacturing Indexes (PMIs) in major developed and emerging markets have trended negatively over the last 6 months, based on JPM Global PMI readings, indicating that economic output is waning.
Of course, bulls will point to December’s selloff as proof that the discounting mechanism of markets has reflected this into prices and that valuations are now in line to support what most are expecting to be lackluster earnings in the early part of this year.
More concerning may be investor skepticism toward developed markets as the MSCI EAFE IMI index has failed to rebound in January like a majority of its counterparts, especially when measured in U.S. dollars. In times of geopolitical uncertainty and slowing economic growth, one would expect emerging markets to be the group suffering the most, but the recent Federal Reserve dovishness and rebound in commodities prices has supported shares.
U.S.–China trade rhetoric/optimism may also be a major factor behind the below divergence between the emerging and developed baskets.
To note, an over 8% divergence between the two has emerged in just 146 days.
Developed Markets have Failed to Bounce Back from December’s Selloff
Source: Bloomberg Finance, L.P., data from September 20, 2018 to February 12, 2019. Global Markets is represented by the MSCI ACWI IMI, Developed Markets is represented by the MSCI EAFE IMI, Emerging Markets is represented by the MSCI Emerging Markets IMI and U.S. is represented by the MSCI USA IMI.
Money in Motion
- Whether driven by tax loss harvesting or year-end rebalancing, flows into international ETFs, especially emerging markets have vastly outpaced those into U.S. or developed markets.
- More recent data around flows and positioning suggests that a real trend towards EM assets may be occurring, as longer term flows (12, 24, and 36 months) have largely leaned towards Developed Markets.
Net Flows, in $ Millions
Source: Bloomberg Finance, L.P., as of February 12, 2019. Data represents U.S.-listed ETFs targeting broad-based exposure to Developed Markets and Emerging Markets, respectively.
What’s Next?
- The outcome of the U.S. – China trade deal represents a significant source of uncertainty for the direction of this pair in the near-term driven by the connectivity of trade between China and the rest of the world. In fact, developed markets index heavyweights like Japan and Germany represent China’s two largest developed markets trading partners outside of the U.S., which is its largest.
- However, YTD price action clearly suggests some optimism around a deal coming to fruition, or at least some positive developments before the proposed March 1st deadline. Outside of Brazil, China has been, by far, one of the best performing EM country year-to-date. China, as measured by the MSCI China Net Total Return Index (in USD), has gained over 12% as of the close yesterday.
China’s Top Ten Trading Partners Show Linkages Across Developed and Emerging Markets
Source: World Bank, as of February 12, 2019.
Implementation Ideas
For investors looking for the continued upside in emerging market assets, whether driven by a weakening USD or continued developments around trade, the Direxion MSCI Emerging Over Developed Markets ETF (RWED) offers them the ability to benefit not only from emerging markets potentially performing well, but from emerging markets outperforming developed markets.
Conversely, if investors believe that resolutions to the big issues impacting sentiment today are in motion, the Direxion MSCI Developed Over Emerging Markets ETF (RWDE) provides a means to not only see developed markets perform well, but a way to access a convergence/catch-up in performance of DM relative to EM, a spread that has clearly widened over the past 6 months.
Risks: Investing involves risk including possible loss of principal. The ETFs’ investments in derivatives may pose risks in addition to, and greater than, those associated with directly investing in or shorting securities or other investments. There is no guarantee that the returns on an ETF’s long or short positions will produce high, or even positive returns and the ETF could lose money if either or both of the ETF’s long and short positions produce negative returns. Please see the summary and full prospectuses for a more complete description of these and other risks of the ETFs.
Distributor: Foreside Fund Services, LLC