Emerging Markets: Why Goldman Sachs Sees More Pain

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Emerging-market ETFs vaulted to three-month highs Monday as the U.S. dollar weakened against most major currencies and better-than-expected trade numbers from China boosted investor confidence.

Although they've regained a great deal of their losses from the summer sell-off, some Wall Street powerhouses expect the pain to return because of a double head wind from the Federal Reserve cutting back monetary stimulus and China's slowing growth. They recommend investors sell any short-term rallies -- especially countries with large trade deficits, which benefited most from the Fed's easy-money policies.

Vanguard FTSE Emerging Markets ( VWO ) -- the largest of its kind -- surged 3% while booking a seven-day winning streak -- the longest one this year.IShares MSCI Thailand ( THD ) andiShares MSCI Turkey ( TUR ) outran most nonleveraged ETFs, spiking 6%.IShares MSCI Indonesia ( EIDO ) followed with a 5% rally.

Flagship ETFs tracking the four-largest emerging markets --iShares MSCI Brazil ( EWZ ),Market Vectors Russia ETF (RSX),WisdomTree India Earnings (EPI) andiShares China Large-Cap (FXI) -- jumped 2.5% to 3.6%.

Emerging markets may have already priced in the start of tapering, but countries with the largest trade deficits -- India, Turkey and South Africa -- will continue to underperform those with trade surpluses -- China and Russia -- given that tapering will persist through much of 2014 and interest rates will be increased in 2015, Alec Young, global equity strategist at S&P Capital IQ, wrote in a report Monday.

What's more, Indonesia and Brazil's efforts to support their currencies by raising interest rates could have unintended consequences like slowing economic growth, fueling inflation and depressing bond prices.

Despite the summer sell-off, "most emerging-market assets still do not look particularly cheap," Goldman Sachs wrote in an "Emerging Markets Weekly" report released Sept. 5. Rising U.S. economic growth and interest rates will affect the global markets for much of the next two to three years and emerging-market currencies will weaken further against the dollar and in turn lift interest rates, Goldman wrote. But it's doubtful that there will be another 1997-like crisis.

"Foreign debt levels -- including short-term debt -- are much lower than they were then, current accounts in general are smaller and reserves are much larger," Goldman wrote.

While the effects of a strengthening dollar remains to be seen, developing countries' stock markets are just undergoing a correction -- not a crisis, according to BlackRock, which noted that they've undergone double-digit sell-offs multiple times in the past 10 years and still managed to outperform developed markets over the long run.

IShares MSCI Emerging Markets (EEM), the oldest of its kind, returned an average annual 11.67% in the past 10 years. By contrastiShares MSCI EAFE (EFA) returned an average annual 7.49% and SPDR S&P 500 (SPY) 7.11% over the same period.

FXI confirmed a new uptrend last week when it broke above its 200-day moving average. RSX broke above its long-term, 200-day moving average Monday for the first time in six months, confirming a new uptrend. However, VWO, EWZ and EPI all still trade below that key technical indicator, which means their recent gains have be considered countertrend rallies.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: EIDO , EWZ , THD , TUR , VWO

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