Now's the Time to Buy Emerging Market ETFs as a Low-Valuation Play

By Max Isaacman  NOV 05, 2012 12:35 PM

Though this sector has lagged other markets, it has the potential for a solid comeback.

 


MINYANVILLE ORIGINAL In my book Winning With ETF Strategies (Minyanville/FT Press, 2012) there are graphs from Guggenheim Funds that shows how stocks, in this case the S&P 500 Index (INDEXSP:.INX), performed against bonds in six 10-year periods. In those periods, stocks outperformed bonds in every decade except the last one, the decade of 2000-2009. Stocks are expected to outperform since they have more risk. Bonds are relatively safer than stocks. With stocks there are no guaranteed prices, and stocks sell at whatever price people will pay for them. Bonds are different, and if they are held to maturity, and the issuing company has the cash, the bonds will be paid off at par.

In the last decade bonds outperformed stocks – no surprise because almost everything outperformed stocks, including Treasury bonds, silver, gold -- even Treasury bills outperformed stocks. That decade is an inverted performance for stocks, and will not likely be repeated. In the past 100 years there have been short periods when bonds outperformed stocks, but over longer periods stocks have outperformed.

In Winning with ETF Strategies it is pointed out that investors should determine at what point in a cycle the market is in and where it might be heading. Markets move in cycles, which take years to complete. Using the Dow Jones Industrial Average (INDEXDJX:.DJI) as a barometer, over the past 113 years there were more bear market years than bull market years. Bull markets lasted an average of 10 years, and bear markets lasted an average of 18 years. The bear years were more like sideways markets than big down markets.  In bear/sideways years investors and traders are pessimistic and cling to negative news and generally hate the market, while trying to profit by its moves. In bull market years caution is generally thrown to the wind, and risk profiles are downplayed, while investors and traders (myself included) think how smart they are. Meaning they are making money.

Definitely we are in a bear/sideways cycle, and have been for about 12 years. However, there is hope, and the market feels more like a market bottom than the a market that has about doubled from its lows.

Stocks should do better than bonds this decade, and should do better than many other asset classes. Studies show that asset-class exposure is the most important determinate in how a portfolio will perform. You have to determine the asset class that will outperform, and also determine the amount of risk you can assume, both financially and emotionally.

Even though stocks performed badly this past decade, certain slices of the market, such as small-cap stocks, and stocks in the energy sector and the health-care sector, performed well. Although asset class buying is not the same as buying the general market, such as buying the S&P 500 or the Dow Jones Industrial Average, that can be the best way to invest, if you pick the right sectors. Buy the Laggards

Emerging markets have lagged the US market advance and probably will catch up, and should be bought as a low-valuation play. For instance, in the first three quarters of 2012 the China GDP is up 7.7% , and the economy could meet the government’s 7.5% target for the full year.

There is much skepticism about China, investors questioning the country’s direction and the veracity of its reporting; China’s economy and future has been called “roach hotel” by a hedge fund manager. In a global economy that is seeking growth, if China can maintain its growth or anywhere near it, it will help the Asian economies, as well as helping global growth.

If you want to invest in China, and I think China long term will be a good buy, there are less risky ways to do so. One way is to buy China through ETFs that include China in its portfolios along with other emerging countries. If China does well the emerging markets will do well, but emerging markets are not solely dependent on China performing.

The WisdomTree Emerging Markets ETF (NYSEARCA:DEM) has about 15% China in its portfolio and has a 4.05% dividend. DEM has often outperformed its benchmark, which is the MSCI Emerging Markets Index (NYSEARCA:EEM). The WisdomTree Small-Cap Emerging Markets ETF (NYSEARCA:DGS) has about 4% exposure to China, and pays a current dividend rate of 3.35%. The RevenueShares ADR Fund ETF (NYSEARCA:RTR) has a China exposure of 12% and pays a 3.64% dividend. RTR is weighted by revenues, and gives exposure to developed countries as well. Some ETFs in these countries are selling are selling at multiples that are priced to a continuing recession, but recessions do end.

For pure-play China, the recently launched WisdomTree China Dividend Ex-Financial ETF (NYSEARCA:CHXF) is a well-diversified way to play that country. CHXF has about 40% of its holdings in small and mid-cap companies and about 60% in large cap, which is a reasonable balance.  It is expected to pay about a 3% dividend, and sells at about 12 times earnings, a low multiple.   

Certainly there is sentiment for emerging markets to move higher. WisdomTree’s Jeremy Schwartz wrote that the current dividend yields for emerging markets indexes in 2012 are in one of the high dividend yield periods. These periods were historically associated with higher performances in the following calendar years. Schwartz’s team broke 23 years of index data into two buckets. The positioning of various years into these buckets was based on their trailing 12-month dividend yield values of each respective calendar year. The results showed that the 12-month dividend yield had a definite connection with the returns of the following calendar years.

WisdomTree’s calculations showed that as of April 30, 2012, the 12-month dividend yield of emerging markets equities was 2.93%, which would rank as the fourth highest dividend yield year of the 23 calendar years studied. The calendar years 12-month performance for the highest dividend years, in the following 12 months, averaged over 17% better than the average performance of all 23 calendar years.

This performance should not be judged in isolation, but is shown as a further reason to consider investing in emerging markets, which have lagged other markets but have the potential for a solid comeback.
Positions in DEM, DGS, and RTR.