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Emerging Market ETFs Showing Signs Of A Breakout

Emerging market ETFs are once again giving us a reason to pause and take notice of their price momentum relative to the opportunities in the developed investment world. Despite multiple years of sub-par returns, these countries have a variety of attractive characteristics that make them worthy of your attention. Whether you are a value seeker, trend follower, or asset allocator – the wealth of available opportunities in this market makes for a compelling investment case.

The two largest ETFs in this space are the iShares MSCI Emerging Market ETF (EEM) and the Vanguard FTSE Emerging Market ETF (VWO). Despite their broad-based nature and massive assets, these funds actually have significant differences in their underlying fees, country exposure, and sector dispersion. This makes for a notable variance in the total performance of each strategy, which may ultimately draw investors to owning both funds as a more diversified emerging market allocation.

Assets ($ billions) $30.10 $64.40
Expense Ratio 0.69% 0.15%
Top Countries China (23%) China (25%)
S Korea (15%) Taiwan (14%)
Taiwan (13%) India (12%)
Total Holdings 844 1016

From a technical perspective, we are seeing both funds break out of a six month range that is primarily being driven by the strength in China. As the top holding in both funds, China has a significant pull on the total return of these strategies and is often a leading indicator of emerging market impetus.

A look at the chart below shows how VWO has also sliced cleanly through its 200-day moving average on the upside.

VWO has now gained more than 7% this year compared to less than 2% in the SPDR S&P 500 ETF (SPY). However, the majority of that move has come in the last three weeks as VWO has rocketed higher despite the sideways malaise of U.S. stocks.

For the moment it appears as though the emerging market move has flown largely under the radar. The majority of the investment community has been fixated on currency hedged ETFs in Europe, Japan, and other developed nations. VWO has actually had negative outflows of 374 million year-to-date and EEM has lost over $3 billion.

So what’s driving these recent returns and what fundamental catalysts may keep them going?

One of the foremost headwinds for international investments denominated in U.S. dollars has been the strength of the PowerShares U.S. Dollar Bullish Index Fund (UUP). A strong dollar actually works against traditional emerging market funds such as VWO and EEM. Nevertheless, over the last several weeks, we have seen the dollar begin to slide and create a favorable environment for these stock funds. Further weakness in the benchmark U.S. currency moving forward would likely bode well for emerging market ETFs.

Another catalyst for the strength in emerging markets has been the change in tenor for the United States Oil Fund (USO). Crude oil prices have arrested their slide and appear to have stabilized on a short-term basis from their multi-month downtrend. Many emerging market countries in Eastern Europe and Latin America are highly correlated to the price action of oil because of their heavy reliance on this commodity to their economic prosperity. If oil continues to move higher from here, it would likely act as a tailwind for emerging market stocks.

Another feather in the cap for the emerging market story is the concomitant strength in fixed-income. The iShares JP Morgan USD Emerging Market Bond ETF (EMB) is one of the sturdiest sectors of the bond market in 2015 with a total return of over 4% in just a few short months. This ETF has also broken out above key resistance levels that proved difficult to overcome, but will likely draw renewed interest from income investors looking to boost their yield and diversify overseas.

It’s important to remember that there is a wide menu of options available for those that want to participate in this theme. Conservative investors may be drawn to the iShares MSCI Emerging Markets Minimum Volatility ETF (EEMV) as a low volatility option for their portfolio. Additionally, those that are concerned about the currency impact of their foreign holdings may want to consider the Deutsche X-trackers MSCI Emerging Markets Hedged Equity ETF (DBEM). Of course there are also a variety of country-specific, sector and other fundamentally screened options available as well.

Disclosure: At the time this article was written the author was long EEM and clients of FMD Capital Management owned VWO and EMB.

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

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