U.S. equities began the week with more volatility reigning as the Dow Jones Industrial Average fell over 400 points to start Monday’s trading session, but as investors become accustomed to this new normal, ETF Trends Publisher Tom Lydon is keen to notice one particular trend–the continuous flow of capital into emerging markets.
The capital markets got a reprieve from the ongoing trade wars between the United States and China as U.S. President Donald Trump and Chinese president Xi Jinping agreed to cease fire on their tariff-for-tariff battle last week. As part of the agreement, both nations agreed to withhold imposing further tariffs on each other for 90 days while they work out a firm, ironclad deal to start 2019.
However, volatility crept back into U.S. equities as the reality of a permanent trade agreement was still open for discussion with contentious topics like forced technology transfer and intellectual property possibly derailing negotiations. Things got worse when news broke that Meng Wanzhou, the CFO of Huawei, one of the world’s largest mobile phone makers, was arrested in Canada and faces extradition to the US, which could also squelch a permanent trade deal.
Despite more global news, such as a delayed Brexit vote in Parliament, bringing down U.S. equities, emerging markets investors remain unfazed during Monday’s session.
“Around the world, we’ve got a lot of concern,” Lydon said during Fox Business Network’s “Mornings with Maria” on Monday. “However, there’s something that’s peeking its head out, which is emerging markets. We’re starting to see a lot of money move into emerging markets ETFs, which I think are investors looking for value.”
While the majority of investors might be driven away by the red prices in emerging markets during much of 2018, Lydon believes they should be looked at as substantial markdowns, especially if trade negotiations between the U.S. and China result into something materially positive–a result emerging markets bettors are hoping for. From a fundamental standpoint, low price-to-earnings ratios in emerging markets ETFs have made them prime value plays as capital inflows continue.
“We look at flows that are going into ETFs and out of ETFs that really tell us where smart money might be going,” added Lydon with regard to an influx of $264 billion in ETFs year-to-date.
Emerging markets have been marred by the trade wars between the U.S and China, causing a negative ripple effect into emerging market ETFs, such as the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO)–down 11.82% YTD, iShares Core MSCI Emerging Markets ETF (NYSEArca: IEMG)–down 12.33% YTD and iShares MSCI Emerging Markets ETF (NYSEArca: EEM)–down 12.24% YTD. Nonetheless, the YTD pains these ETFs have been experiencing through the majority of 2018 appear to be subsiding.
Despite the deep declines, with respect to value compared to price, many of these ETFs from abroad present a profitable opportunity that can be realized, especially if China and the U.S. ameliorate their trade differences. It presents an interesting opportunity for the investor who is seeking value in terms of locating discounted assets.
Fixed Income Inflows, Large-Cap Bellwether
As equities continue to sell off, Lydon is also noticing that inflows into the tried-and-true safe haven of bonds is becoming more readily apparent as flows into fixed-income ETFs increase. In addition, large cap equities will continue to be the bellwether that signals where the market will be heading, especially as portfolios experience shifting ahead of 2019.
“Large cap growth has been the bellwether where we haven’t seen money come out,” said Lydon. “We’ve seen a lot of money going out of money like quality, value–those factors for sure, especially ETFs around the world continue to sell off, particularly as the markets continue to get weaker.”
Needless to say, money managers will be closely watching market behavior to end 2018 as one more rate hike by the Federal Reserve is on the horizon and geopolitical factors like trade wars will give an indication of where to allocate capital before the new year.
“The key thing here as we go into the end of the year–managers are on a precipice–‘Am I going to show big cash values or allocations at the end of the year because my clients are concerned on what might be coming on next year? I don’t want to look like I’m fully invested if the market’s declining,'” said Lydon.
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