Betting Against Submerging Markets

So far this year, the developed markets have continued to deliver while, across the pond, the emerging markets have suffered a meltdown. Year-to-date, the SPDR S&P 500 ETF (SPY) -- which includes holdings like Exxon (XOM), Apple (AAPL), Microsoft (MSFT), IBM (IBM), and Bank of America (BAC) -- is up 6%. The iShares Advanced Market (ex-North America) ETF (EFA) has risen 5%. In contrast, the iShares MSCI Emerging Markets ETF (EEM) is in the red: off by more than 4%. Drilling down into country-specific ETFs, the damage done becomes even starker: year-to-date, India (EPI) has nose-dived 15% while Thailand (THD) and Chile (ECH) have both fallen 10%.

(To read Quint Tatro's reasoning on why traders should hold AMD and Google, click here.)

Here in the US, rising corporate earnings, positive economic data and easy money have buoyed this stock market. Investors have taken notice and become more optimistically-inclined: according to fund tracker EPFR, for the week ending February 11, US equity funds posted inflows for the ninth time in the past 10 weeks. However, these same investors are currently just as downbeat on those once-red hot emerging markets. Indeed, says EPFR, you and your neighbors pulled more than $3 billion out of emerging markets equity funds for the week ending February 11. These funds have now suffered three straight weeks of outflows in early February, which amounts to their worst three week run in three years as worries about the economic and political consequences of fast-rising inflation continue to punish this asset class. Investors, after reading about these headline-making declines, are searching for ways to profit from the dramatic sell off. There are different exchange-traded funds available for such purposes. For instance, there are vehicles that offer the inverse return of a broad emerging markets index. That is, these ETFs go up when the emerging markets go down.

(To see Damian Thompson's thoughts on Pandora's IPO, click here.)

Two such exchange-traded funds that strategists highlight include a non-leveraged fund, ProShares Short Emerging Markets (EUM), and a double-leveraged fund, ProShares UltraShort Emerging Markets (EEV). One big difference besides the leverage, pros point out, is that the EEV trades 10 times more shares per day, which makes it more liquid, meaning it has more shares that trade more often so it's effectively easier to buy and sell. Even as investors yanked $3.3 billion from the emerging markets ETFs in January, according to Morningstar, they have committed capital to these two funds. In January, the EEV enjoyed inflows of $43 million; $2.4 million for the EUM. Year-to-date, the EEV is up 8% while the EUM has climbed 4%. Still, despite the lack of love for the emerging markets right now, other economists and strategists argue that betting against these developing areas of our world could prove a bad bet for investors.

(To see Carol Kopp's thoughts on why Bing is better than Google, click here.)

Bill Witherell, chief global economist at New Jersey-based Cumberland Advisors, says that unless there is a serious deterioration in geopolitical developments, he expects that the underperformance of emerging-market ETFs will be a correction of relatively short duration. The secular boom in emerging-market economies is likely to reassert itself by mid-year, if not earlier, he says. Twin forces will help these markets regain their footing: the ongoing boom in commodities markets and the continuing recovery in the US and other major advanced-economy markets. Witherall therefore views the current correction as a time to be looking for emerging markets that are the most likely to bounce back to outperform in the coming months. The emerging countries of Asia again seem the most likely to be the leaders, in his view, which would include South Korea (EWY), Malaysia (EWM), Hong Kong (EWH), and China (GXC). Alec Young, S&P's international equity strategist, argues that while inflation worries will likely fuel additional emerging market equity volatility over the next few months, he recommends maintaining exposure to this asset class. The S&P global asset allocation includes stocks, fixed income and cash equivalents, and dedicates 7% of the total to emerging market equities.

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