Near-Term Momentum For Emerging Markets ETFs

Sometimes, “better” is a relative term, but there is no denying the Vanguard Emerging Markets Stock Index Fd VWO, iShares MSCI Emerging Markets Indx (ETF) EEM and other emerging markets exchange-traded funds are certainly acting better to start 2016 than they did in previous years.

This year, “better” for VWO and EEM, the two largest emerging markets ETFs, means a loss of 1.1 percent. Off their late January bottoms, VWO and EEM are up an average of 9 percent. That move underscores the notion that while the prominent bear case against emerging markets has not been extinguished, developing world equities have some near-term momentum.

Headwinds And Momentum

Those headwinds include eroding earnings, which have made emerging markets stocks appear inexpensive, capital outflows and the impact of higher U.S. interest rates and dollar-denominated emerging markets debt.

Still, recent momentum for emerging equities cannot be glossed over, particularly against the backdrop of weakness in China.

Related Link: These China ETFs Are Ready To Rally

“A narrative is developing that the increased liquidity (i.e. ~$4 trillion in recent loan growth) is going into the real economy, rather than financial markets. What that means is that locals are starting to speculate again in real estate instead of the stock market. While this will come back to haunt everyone again, that is a story for next fall, not for today,” said Rareview Macro founder Neil Azous in a note out Wednesday.

Switch Pitch

Another catalyst for emerging markets stocks and ETFs has been the laggards turning into leaders trade, notably Latin America. For example, the iShares S&P Latin America 40 Index (ETF) ILF is up nearly 17 percent off its late January bottom. Year-to-date, the Brazil/Mexico heavy ILF is higher by almost five percent after plunging 31.5 percent last year.

Serving as a reminder to the significance of the drag on ETFs such as EEM and VWO Latin American stocks have been, ILF has not closed higher on an annual basis since 2012.

Azous highlighted the Mexican central bank's recent interest rate hike.

“The Banxico broke away from the Fed with a bunch of preemptive actions. They showed clear evidence that they are their body and don't take marching orders from the US, in a similar fashion to how the ECB dictates Sweden and Switzerland policy,” he said.

Although Banxico was quick to say its rate hike does not mark the start of a new tightening cycle, it is...interesting that the iShares MSCI Mexico Inv. Mt. Idx. (ETF) EWW is up 6.1 percent since the rate hike on February 17.

As an aside, EWW's pop since the rate hike reminds of a recent conversation where EWW was proposed to be moving higher because of the rate hike. Within the chat, the other participant in the conversation retorted, citing ancient academic theory about how stocks cannot go up after rate hikes. One would think that to be nonsense, particularly when a country with a depressed currency, such as Mexico, raises rates.

EWW's recent showing may give the initial argument some validation.

Disclosure: Todd Shriber owns shares of VWO.