For what feels like an eternity, market pundits have been
calling for the "great rotation" from bonds to stocks. A rotation
is happening, but elsewhere.
The problem with the bonds-to-stocks rotation is that outside of
a couple of head-fakes, borrowing rates have remained stubbornly
All the while, investors have indeed been reallocating, but in
perhaps a different manner than most had anticipated; namely, out
of emerging markets equities and into their developed market
The two largest emerging markets
-the Vanguard FTSE Emerging Markets ETF (NYSEArca:VWO) and the
iShares MCSI Emerging Markets ETF (NYSEArca:EEM)-have lost more
than $11 billion in assets in 2013.
On the other hand, the Vanguard FTSE Developed Markets ETF
(NYSEArca:VEA), the PowerShares QQQ Trust (NasdaqGM:QQQ), the SPDR
S&P 500 ETF (NYSEArca:SPY) and the iShares MSCI EAFE ETF
(NYSEArca:EFA) have collectively seen more than $13 billion in
over the first seven-plus months of the year.
This dichotomy speaks to a shift not just in assets, but also in
the global economy.
As our own Matt Hougan recently pointed out, the total market
segment of the emerging markets space has been extremely weak in
2013. The iShares Core MSCI Emerging Markets ETF (NYSEArca:IEMG)
that tracks perhaps the most comprehensive emerging markets
index-the MSCI Emerging Markets IMI-has fallen more than 9 percent
A combination of monetary tightening measures in China; civil
unrest in Turkey and Brazil; and economic restructuring has made
world less appealing relative to the
world-regardless of the fiscal challenges facing the latter.
Call it the cleanest-dirty-shirt dynamic.
While it may seem easy to pick apart the logic of transitioning
assets to developed equities markets, the fact is that U.S.
equities and the iShares MSCI EAFE ETF (NYSEArca:EFA) are both up
this year, and even the iShares MSCI EMU ETF (NYSEArca:EZU) is
quietly up 3 percent year-to-date, while emerging markets sit well
in the red.
Meanwhile, the IMF recently cut its growth forecast for emerging
markets-along with the rest of the world-citing, among other
things, a negative outlook for exports.
To that end, the inability of emerging markets to grow and
maintain exports in a world where nearly all central banks are
openly debasing their currencies poses perhaps the biggest obstacle
and opportunity for these markets.
On the one hand, so much of the developing world's returns over
the past decade have been fueled by resource and manufacturing
Any sustained weakness in export markets should therefore have a
massive impact on the profitability of the key firms in these
markets. Moreover, increasing energy independence and efficiency in
the developed world threatens to further erode large pockets of
On the other hand, a massive amount of policy and capital has
been dedicated to fostering a new, domestic demand-dependent
economic model in these countries, and we may be seeing a paradigm
shift in the way emerging market economies grow.
Friday's announcement of a policy shift in Beijing aimed at
liberalizing corporate lending laws is the most recent example of
how elected officials are trying to redirect resources to
consumer-driven sectors of the economy.
If we are indeed seeing this type of economic restructuring, it
bodes well for the future of the emerging markets even if it does
not necessarily portend short-term gains.
After all, a transition of this scale-exports still represent 30
percent of China's GDP-won't happen overnight. The current economic
powerhouses in the emerging markets-basic materials, energy and
financial firms-will become incrementally smaller pieces of the
As that happens, some of the sectors that serve consumers, like
those found in the EGShares Emerging Markets Consumer ETF
(NYSEArca:ECON), may indeed outperform. That is quite possibly what
we're seeing now.
But it bears mentioning that the developed world will still have
a big role to play in this shift.
The fact is that many of the largest consumer firms in the world
are domiciled in the developed world. These are the firms with the
size and scale now to profit from increased discretionary spending
in the emerging world.
It's these sometimes-complimentary and sometimes-competing
forces that investors weighing the emerging-versus-developed debate
have had to wrestle with.
Given the current landscape, we could continue to see investors
have a marked bias to the developed world, at least until the
emerging markets can prove them wrong.
At the time this article was written, the author held no
positions in the securities mentioned. Contact Paul Baiocchi at
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