The Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO), the largest emerging markets exchange traded fund by assets, is lower by 8% year-to-date. Not surprisingly, some market observers are citing the Federal Reserve’s tighter monetary policy as one reason for the slump in developing world equities.
The recently resurgent U.S. dollar could be one reason why investors are retreating from emerging markets equities. A stronger dollar raises external financing costs for developing economies and usually leads to lower commodities prices, a relevant point because many developing commodities are major commodities exporters.
“Tightening US financial market conditions are putting the synchronized global growth narrative to the test, with emerging markets being the first casualty,” according to the latest Equity Market Drivers Report from global index provider FTSE Russell.
Despite the relative weakness year-to-date in emerging markets ETFs, other market experts may view them as underpriced based on a price-to-estimated earnings ratio that is at its lowest within the last two years. The ratio for the MSCI Emerging Markets Index is below its historical average of 11.4, reaching about 11.2–signs that possible buying opportunities exist. VWO tracks the FTSE Emerging Markets Index.
Uncertainty, But There Is Growth
Uncertainty and political volatility are significant headwinds for emerging markets stocks to overcome, but many developing economies offer earnings growth. Earnings growth in developing economies could be a sign of upside to come for emerging markets stocks and ETFs. Emerging markets are expected to post robust earnings growth this year and in 2019.
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Still, some investors’ risk appetite may be limited for developing economies, particularly with Chinese stocks slumping. China is usually the largest geographic exposure in an array of emerging markets ETFs, including VWO.
“After a couple of years of synchronized growth and increased risk appetite, tightening US financial conditions suggest we are close to the end of this phase of robust global growth,” said FTSE Russell Managing Director Philip Lawlor. “The slippage in leading indicators, flattening US yield curve, commodity selloff and the fading trend in forward-looking GDP forecasts all suggest that the global cycle is peaking: investors will be tempted to ask if this is as good as it gets. Risk appetite and dollar-dependent emerging markets are the first casualties of tightening US-dollar liquidity, and emerging-market sentiment remains extremely negative.”
For more ETF trends in emerging markets, click here.
Tom Lydon’s clients own shares of VWO.