Any Bright Spots In Emerging Market ETFs? [iShares MSCI Emerging Markets Indx (ETF), Vanguard FTSE Emerging Markets ETF]

market outlookNot that long ago, many emerging market countries were struggling with the “problem of plenty”. Ultra-low interest rates in the developed world coupled with higher growth prospects in these countries led to a surge in capital inflows. Massive inflows complicated monetary management and led to appreciation of currencies.

The beginning of the end of cheap-money era is now causing turbulence in these markets. As foreign investors head for exits, currencies of countries like Argentina, Turkey, Brazil and South Africa plunged to their multi-year lows and their stock markets swooned.

Further, many emerging countries profited from China’s enormous appetite for commodities in the past few years.  Concerns about slowing growth in China as well the health of its huge shadow banking system are causing tremors in commodity exports dependent economies.

For some countries, factors are mostly internal—woes of their own making. Current crisis just exposed the structural problems that already existed in these countries. Their policymakers failed to address those severe problems when the going was good. (Read: 5 ETF Prections for 2014)

Unfortunately, in times of panic, inventors tend to lump and punish all emerging markets together. But looking at slightly longer-term picture, there may be some pockets of opportunity within the space. Investors need to focus on macroeconomic fundamentals and discriminate the stronger economies from the weaker ones.

A look at the Recent Performance

The broader emerging market ETFs Vanguard Emerging Markets ETFs (VWO) and iShares Emerging Markets ETF (EEM) are down more than 8% this year and many have fared worse.   iShares Turkey ETF (TUR) and Market Vectors Russia ETF (RSX) are among the worst performers—losing more than 11% this year.

On the other end of the spectrum, some smaller emerging markets/frontier markets did very well.  Market Vectors’ Egypt (EGPT) and Vietnam (VNM) ETFs are up close to 11% this year.

Central banks in many countries rushed with several measures including rate hikes to stem the slide of their currencies and halt the exodus of foreign capital.

Turkey announced a massive rate rise but the respite for the beleaguered currency was rather short-lived.  Indian rupee fared only slightly better after the rate hike. Brazil and South Africa did the same but the actions failed to help their currencies.

Which Countries are Most Vulnerable?

In my view, investors should avoid emerging countries from the following four groups.

1)    Taper Tantrum: Countries that are dependent on foreign capital to finance their external deficits remain most vulnerable to the Fed’s tapering plans. Turkey, South Africa, Brazil and Indonesia look most risky looking at their current account deficits and external debt situation.

2)    Structural Problems: Argentina and Venezuela are the easiest to classify in this group. Turkey and South Africa come to mind next. BRIC countries also suffer from some structural issues that will continue to cause problems going forward.

3)    Political Uncertainty: All “Fragile Five” countries—Brazil, Turkey, India, Indonesia and South Africa—have general elections this year, which will keep these markets volatile. Countries like Turkey, Ukraine and Thailand are also facing political unrest, which makes their ride rough.

4)    Dependence on China: Slowing demand in the world’s largest consumer of commodities does not bode well for countries like Brazil, South Africa and Indonesia. They have had their days in the sun and the picture looks cloudy now.

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