Up until very recently, investing globally was a relatively easy way to provide outperformance for your portfolio. The strategy was actually quite simple. Since the U.S. stock market is rarely the global leader, you simply needed to find those regions of the world that were performing better than the good ol’ USofA. And for a long time, investing in the emerging markets when the U.S. market was rising was an easy way to provide a turbo-boost to your returns.
However, this game plan has clearly hit a bump in the road recently as the combination of the European debt crisis and the uptick in inflation in places like China, India, and Brazil has forced money out of foreign lands and back into the U.S.
Take a look at the charts of some ETF’s for China, India, Brazil, the emerging markets, and the U.S. shown below, and the picture becomes quite clear. While the U.S. has enjoyed a joyride to the upside since QE2 was announced in the fall, the emerging markets have not been the place to be.
S&P 500 - Last 12 Months
Now that’s an uptrend! And because of the big bounce in U.S. stocks, our market is now the global leader. This hasn’t happened been the case in a very long time! Now compare this trend to those seen in the emerging markets below:
iShares Emerging Markets Last 12 Months
iShares China 25 Index Last 12 Months
WisdomTree India Last 12 Months
iShares Brazil Last 12 Months
I believe the word you’re looking for with respect to these charts is U-G-L-Y!
I know what you’re thinking; hasn’t China led the world out of the economic abyss over the last two years? Aren’t China and India two of the worlds’ fastest growing economies? Isn’t this where many companies are focusing their growth efforts? Don’t these countries have burgeoning middle classes that will continue to fuel growth? And don’t people say to “go where the growth is?”
The answer to all of the above questions is indeed, yes. However, with the combination of rapid growth and a little thing Mr. Bernanke calls QE2; inflation has become a problem in many of the emerging markets. And how do governments deal with inflation? Oh, that’s right, they raise interest rates. And if you’ve been around this game for any length of time, you know that one of the first rules is “Don’t Fight the Fed (of any country) – Especially when they are on a mission.”
While it would be easy to blame the political upheaval in places like Egypt for the recent difficulty in the emerging markets (after all, investors did pull $10 billion out of emerging-market equity funds in the two weeks ending 2/9), it is important to recognize that the exodus from the emerging funds has been going on for some time now. Again, the charts above show that the emerging arena has been a problem since November.
As the WSJ reports, “The shift out of emerging markets wasn't a traditional pullback from risk to safety; instead it was a rotation of risk appetite. Emerging markets face big challenges after their strong rebound from the crisis: inflation has surged higher, fueling concerns that some central banks, fearful of high capital inflows and currency appreciation, are behind the curve in tightening policy.”
Another factor affecting the allocation move from emerging markets to places like the U.S. is stock market valuations. In a research note, Barclays Capital mentioned that developed markets are better values because they are at an earlier stage in their business cycles. And as we pointed out in a recent article on valuations it appears that valuations in the U.S. remain reasonable.
However, many analysts point to the fact that the upside may be limited in the U.S. due to the lack of job growth in the economy. As such, it would make sense to treat the current allocation to the U.S., which seems to be all the rage these days, as “a trade.” In other words, it is probably best not to get too comfortable in those triple-long S&P funds coupled with the something like the EEV (ProShares UltraShort Emerging markets). Remember, this is not exactly a new trend and as such, it may not be the best time to be establishing short positions.
So, in answering the question posed by the title of this little missive, anyone using the global markets in their portfolio as a turbo charger may need to make some adjustments in their strategy. In short, it has become quite clear that simply substituting the emerging markets for the U.S. markets is not doing the trick at the present time.
For anyone looking to identify the leadership in the global arena, we’d suggest a more active management approach may be applicable. And it is for this reason that we produce our ETF Leaders Report each and every week. The report shows you what is working in our ETF universe over various time frames. The report is free and is something that I consult every week before we reallocate our FlexPro Portfolio.
What if you currently hold the emerging markets, you ask? Our perusal of the chart suggests that you can probably continue hold the EEM as the trend is currently sideways from an intermediate-term perspective. However, a break below $44.50 on the EEM might be a good spot to consider stopping the position out.
Disclosure: At the time of the publication, Mr. Moenning or affiliated companies own positions in the following securities mentioned: none
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