In the wake of Donald Trump's election, emerging-market ETFs tumbled as investors feared that the new administration's protectionist trade policies would hurt the countries in these markets. But then a funny thing happened. After ranking as one of the worst-performing sectors in the last quarter of 2016, emerging-market ETFs began the new year with a rally and are outperforming U.S. stocks.
So far this year, Vanguard FTSE Emerging Markets ETF ( VWO ) has jumped 10%, iShares Core MSCI Emerging Markets ETF ( IEMG ) leapt 10%, and the iShares MSCI Emerging Markets ETF ( EEM ) climbed 10% vs. 5% for the SPDR S&P 500 ( SPY ).
Part of the reason is that prior to the election, 2016 had been a pretty good year for emerging markets. Because many emerging markets are tied to commodities, the prior four years had been pretty bad because of falling commodity prices and slowing growth in China. But in 2016, commodity prices began to rise and China's economic slowdown stabilized.
A big part of the postelection drop was out of concern for the economy of Mexico should Trump attempt to renegotiate Nafta and anxiety over trade barriers with China, according to Mitch Tuchman, chief investment officer at Rebalance IRA, a retirement investment advisor, in Palo Alto, Calif.
Robert Johnson, Morningstar's director of economic analysis, said the recent performance is a continuation of last year's rally. He also said companies and investors have begun to think that, in the wake of Trump's mishandling of the immigration ban , he might not be able to implement his trade policies, especially as he gets pushback from industries hurt by trade bans and tariffs.
Also, since the trade policies haven't yet been defined and investors think most emerging markets, besides Mexico and China, won't be affected, they're jumping back in.
"After five years of underperformance, emerging markets were oversold, and the election flushed out the remaining people hanging on," said Gerald Laurain, chief investment officer with FTB Advisors, an RIA in Memphis, Tenn., with $4 billion in assets under management. "So now that they've established a low, the only place to go is up."
J.J. Feldman, a portfolio manager at Miracle Mile Advisors, a Los Angeles-based RIA, said the valuations are much more compelling. The price/earnings ratio on the emerging markets is 12 vs. an expensive 18 on the S&P 500. He added that emerging-market stocks are yielding 2.25% vs. the S&P's 2%.
Peter Schiff, CEO of Euro Pacific Capital, an asset manger in Westport, Conn., has a different angle. "When there is protectionism, America is the loser," he said. "And tariffs will backfire. People are making the connection that it will weaken the dollar. Meanwhile, the euro is bottoming out and that is better for emerging markets."
"Europe seems to be doing better, and it's more important to China than the U.S.," said Johnson. "There's better growth there, no new rules and other markets they can sell into."
So far through this year, the top country-specific ETFs are all in emerging markets. IShares MSCI Brazil Small-Cap ( EWZS ) has soared 30%, VanEck Vectors Brazil Small-Cap (BRF) surged 26%, iShares Brazil Capped (EWZ) is up 18%, Global X MSCI Argentina up 16%, and KraneShares CSI China Internet (KWEB) up 16%.
After a brutal two-year recession in Brazil, during which President Dilma Rousseff was impeached and replaced by Michel Temer, the country is finally expected to be on the road to recovery. Finance Minister Henrique Meirelles expects the Brazilian economy to return to a 2% annual growth pace by the last quarter of the year. Wall Street is forecasting a more realistic 0.2% growth rate in 2017 gross domestic product. Brazil's economy is driven by resources and commodities. Its top commodity exports are oil, iron ore, soybeans, sugar cane and coffee.
While China is seeing its economy slowing, with GDP expected to post growth of 6.7% for 2016, that's the kind of slowdown most country's would kill for. Right now China is dealing with a cooling housing market, explosive growth in debt, and painful structural reforms instituted by President Xi Jinping.
"E-commerce is going well and that is tapping into a strong part of the economy," said Rob Lutts, president and chief investment officer of Cabot Wealth Management, an RIA, in Salem, Mass. Lutts spends a lot of time traveling in China. "Investing in Alibaba (BABA) is like investing in Amazon.com (AMZN)."
Lutts said that China will have a big challenge over the next five years with a big debt bubble that will have to be distributed over the rest of the economy. This will bring the economic growth rate down to 5% by 2020. "They will have stress when the real estate bubble comes down in price, and that will hurt the smaller banks in the next six months."
But Lutts is very bullish on India. For the fiscal year ended March 2016, India's economy grew 7.9%, and Lutts said it could go higher. Indian Prime Minister Narendra Modi is instituting reforms to remove government obstacles to business and make the government more efficient. Lutts said his favorite way to invest in India is in the financial services sector.
He thinks HDFC Bank (HDB) is one of the best-managed banks in the world. It's also the top holding of iShares MSCI India ETF (INDA), No. 3 in WisdomTree India Earnings Fund (EPI), No. 2 in iShares India 50 ETF (INDY) and No. 3 in PowerShares India Portfolio (PIN). The ETFs' year-to-date gains range from 8.8% to 9.8%.
Overall, all the experts think that because Europe is growing and Trump's policies are still undefined, emerging markets should keep rising throughout the year.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.