Sorry, Investors, You're Wrong About Emerging Markets

By Michael A. Gayed  AUG 22, 2013 12:27 PM

The hatred for emerging markets is unjustified. Since the low, they have performed the same as the S&P 500, and appear to be basing.

 


Reality is wrong. Dreams are for real.
--Tupac Shakur

As I have been stating in my most recent writings, everything takes a backseat to what's happening in the bond market, with spiking yields potentially serving as a near-term catalyst for a correction in equities. Beyond this, however, nothing has changed in terms of the “fat pitch” thesis on emerging market stocks, which seem to be the most hated area of the stock market everywhere I look. The contrarian in me loves seeing headlines like what appeared in the Wall Street Journal, which proclaimed “Mom-and-Pop Investors Bolt Emerging Markets.” Professional surveys of fund managers indicate that portfolio allocations toward emerging market stocks are at their lowest in over a decade. Put simply, so many have sold that there are likely very few left to sell.

As I keep stating, the spread of emerging markets relative to the S&P 500 (INDEXSP:.INX) is the widest it's been since 1998, and yet there has been no event as occurred in 1998. The market has acted with complete certainty that something terrible already happened akin to the Asian crisis of 1997 and the Russian default crisis of 1998. Yes, the parallels exist between now and 1987 in terms of the yield spike and runaway Dow Jones Industrial Average (INDEXDJX:.DJI) outperforming dramatically all year, but against that short-term risk and backdrop is still a massive disconnect in emerging market equities. The spread can conceivable close with US markets falling as emerging markets act resilient. If you think this is impossible, you did not see how many emerging market ETFs were up while the S&P 500 was down several days this month.

The reality is that since the June 24 low, emerging markets are up nearly the same amount as the S&P 500, and yet nearly two months later, everyone seems to be against the trade despite the very logical and real argument that they have priced in a phantom event. Take a look below at the price ratio of the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) relative to the SPDR S&P 500 ETF Trust (NYSEARCA:SPY). As a reminder, a rising price ratio means the numerator/EEM is outperforming (up more/down less) the denominator/SPY.



Looks like a basing pattern to me. Again, everything takes a back seat to what is happening in terms of the yield shock, but facts are facts. Two months ago, I never saw media coverage on emerging markets being an awful investment. Now it's everywhere I look. My firm is out of them for now in our mutual fund and separate accounts, but the trade potential is very much there. I fully expect we will take another swing past this period, but my point here is simple: If you are going to hate on emerging markets off the low, you should then hate on the US markets as well.

This is what contrarians love to see, so long as momentum turns.

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