Things Are Getting Interesting For This ETF, And That's Not Good

With precious little time remaining in 2015, it is now safe to say this will be another dismal year for emerging markets stocks and the relevant exchange-traded funds.

December trading is just a day old, but the Vanguard Emerging Markets Stock Index Fd VWO and the iShares MSCI Emerging Markets Indx (ETF) EEM, the two largest emerging markets ETFs by assets, are off 14.4 percent and 12.8 percent, respectively, year-to-date.

Emerging Markets Still Struggle

As has been widely noted, a plethora of emerging markets single-country ETFs have been noticeably worse. That dubious group includes the iShares MSCI South Africa Index (ETF) EZA. Down 18.4 percent year-to-date, EZA has been plagued by, among other factors, tumbling precious metals prices.

Related Link: Waiting For Godot: Emerging Markets ETFs Try To Get It Together

South Africa is the world's largest platinum-producing country and the second-largest palladium producer behind Russia. That is to say, although the materials sector is not a significant part of EZA, price action in those metals looms large for South African equities.

Second, investors, to the extent that they can be, appear comfortable with the fact that South Africa could very well be the next emerging market to suffer a sovereign credit downgrade at the hands of one of the major ratings agencies. Maybe Turkey will beat South Africa to that dubious punch, but a rating downgrade is still on the table for Africa's second-largest economy.

On the topic of South Africa's tenuous grasp on an investment-grade credit rating, that grasp is growing more fragile, perhaps explaining why EZA entered Wednesday residing just 3.6 percent above its 52-week low.

South African Credit Rating Woes

“Credit default swaps show the nation’s credit rating may be due a downgrade, and economists agree. Twelve of 13 analysts surveyed by Bloomberg said Fitch Ratings Ltd. will this week cut its assessment to BBB-, the lowest investment grade. While Standard & Poor’s should keep its rating at one level above junk, some analysts are predicting the company will lower its outlook to negative. Both companies publish their reviews on December 4,” according to Bloomberg News.

S&P currently rates debt issued by South Africa, Africa's second-largest economy behind Nigeria, BBB-, the lowest investment grade. Fitch Ratings rates South African bonds BBB, while Moody's Investors Service has a Baa2 rating on South Africa. Moody's and S&P have stable outlooks on their ratings of South African debt, while Fitch has a negative outlook.

Investors are skittish about the impact a junk credit rating could have on South African equities as highlighted by about $18 million in outflows from EZA over the past six weeks. At 25 percent, South Africa's unemployment rate is nearly triple that of Brazil's.