Revisiting Emerging Markets ETFs


  • Emerging markets offer the highest growth rates in the world, however, also have some of the highest risks.
  • Reducing risks in emerging markets investing requires you to consider secular trends in technology and demographics, as well as, the rule of law in each country.
  • We want to invest in nations that are young, technologically advancing, are neutral or positive on resources, and where property rights are protected.
  • Those stipulations are rarely all met, so we have to take some ties, and consider reflexivity, in order to participate in emerging markets growth.
  • China is the big wild card as President Xi is as autocratic as any other ruler on earth.

Money values do not simply mirror the state of affairs in the real world; valuation is a positive act that makes an impact on the course of events. Monetary and real phenomena are connected in a reflexive fashion; that is, they influence each other mutually. The reflexive relationship manifests itself most clearly in the use and abuse of credit.

George Soros

Growth in emerging markets economies is projected to eclipse developed markets handily in the next two decades. According to the recent “Megatrend” report by the European Commission, developed markets growth clocks in at about 2%, while emerging or developing markets at around 4%. The fastest large economy growers are China and India, both around 6-7%. 

With emerging markets growth, particularly in Asia and southern economies of Africa and South America, growing at about double the pace of developed western economies and Japan, does that correlate to higher equity growth in those economies as well? The answer is sometimes. 

In order to find winning intermediate term trends within the megatrend, you must invest in nations, regions and themes that have multiple positive factors on their side and are able to mitigate various risks. 

The positive factors that I look for are: 

  • younger demographics.
  • advancing technology.
  • neutral to positive resource positions.
  • property rights. 

Risks that concern me the most are: 

  • aging demographics obligations.
  • unskilled workforces.
  • net financial outflows to buy resources. 
  • autocratic leadership that is empowered to confiscate assets. 

There are certainly more factors to consider, but those are the building blocks I am using to narrow the emerging markets equity universe for finding ETFs and a small basket of focus stocks to invest in. In this week’s “Global Trends ETF” report, I am considering emerging markets ETFs. 

Assessing Emerging Markets Equity Behavior

I am careful with my investing in emerging markets. Despite broadly higher GDP growth than developed markets, it is not as easy as buying a broad based emerging markets fund. Since the Global Financial Crisis, the largest broad based emerging markets fund, the iShares Emerging Markets Index (EEM) has trailed the SPDR S&P 500 ETF (NYSEARCA:SPY) handily. 

EEM v SPY (Kirk Spano via TradingView)

But, what does that chart tell us? Yes, U.S. equity markets have outperformed now for a substantial period of time. However, during that time, the Federal Reserve has expanded its balance sheet by about $8 trillion through quantitative easing or QE. 

The common perception is that “money printing” will hurt the value of a currency. But, has it? Relatively speaking against other major currencies the answer is: no. 

Dollar Relative Value (Kirk Spano via TradingView)

So, how can the dollar have remained strong despite the money printing? The answer is likely two fold. Other central banks also printed money and those nations have less economic strength to absorb the impact of the devaluation.

In other words, the U.S. economy stronger relative to other nations, that it can print more money wit less negative impact, and in fact, relative to those nations, derive a benefit of appreciating currency. 

This is an example of reflexivity. Expectations and understanding versus what happened. And, most likely, those expectations and understandings impacted what actually happened. There was fallibility and a reflexive response.  

So, why am I discussing this with emerging markets. Generally, a strong dollar will hold emerging markets valuations down. In fact, we see that emerging markets did not do as well as the U.S. stock market which had the relatively strengthening dollar. 

That’s not what you get from the chest thumping, foot stomping, table pounding chants of the dollar collapse crowd is it? As I have said repeatedly, do not believe the narratives of traders and ideologues, it is only noise and of little value – except, in trying to figure out what is actually wrong in our quest to find what is right. 

Emerging Markets Winners With A Firm Dollar

As you know, or are about to, I have been a dollar bull since 2012 when I discussed it in a series of articles on MarketWatch. I see the U.S. economy as the superior large economy on the planet and that won’t change in any adult’s lifetime. It might change late in the century, but certainly not before then. That means the dollar, despite crypto, Chinese challenges, Russian incursions, the rise of India and the second best Euro, will remain the defacto reserve currency of the planet, which is, a massive living standards benefit for those using the dollar. 

If I am right, and the dollar stays firm, or at least range bound for an extended period, before heading higher yet again, then what emerging markets stocks will do well? I think the universe is much smaller than the broad index. Like the U.S. stock market, I think we need to ignore over half of emerging markets stocks and more likely closer to 80%. 

So, does that make it too hard to invest in emerging markets stocks? I don’t think so. I think we want to focus on the factors I listed above to find our winners.

Recognize Biases And Adjust Your Thinking

Investing in emerging markets is not much different than investing in U.S. markets. There are just different biases to navigate. 

The main bias I see is the idea that all depressed emerging markets should be treated as some level of opportunity. I don’t think so.

Some markets deserve their current depressed prices more than they deserved the higher prices of a year or two ago. 

A classic mistake has been made by faux analysts that have seen massive losses investing in China and Russia. Those analysts completely missed, and frankly, generally denied, the massive risks involved with investing in autocratic regimes. 

Reflexivity would suggest that investing in China and Russia would precede a shift away from the autocratic tendencies of those regimes. That might be true someday, but someday could be a generation away. Do you have time to wait out the losses? 

In regards to Russia, what if it is a decade before they are integrated back into western financial markets? As for China, what if Xi is able to keep hold of power another 5 years and strips Chinese tech winners of more value in order to build his communist dream utopia while stomping out multiple freedoms? 

Two years ago I said in my webinars week after week: “sell your commie stocks.” Yet, many people glommed onto incongruent backwards looking charts from data miners with limited analytic skills who had no concept of the realities on the ground. Seems like a good argument to actually know your investments. 

The Question Of China

In theory, China represents an exciting investment opportunity. That is, until you consider the entire picture. 

President Xi does not appear to be going anywhere anytime soon. That means property rights do not stand to get better in the short run. And, if Xi were replaced, would we see improved property rights in the intermediate term? I don’t think so.

However, let me share a story with you. When I was a senior in college (way back in 1993), I had a professor who was a dissident from China who spent a few weeks with us in an international political economy class. Here’s what he said (paraphrased):

The Chinese will string along the Americans with promises of future profits for money today. They will dangle the carrot and drink the water. The Americans and other western investors will never get their money back. 

Sounds a lot like Whimpy:

“I’ll gladly pay you Tuesday for a hamburger today.”

In hindsight, he was spot on. Consider the many Chinese companies that have come and gone on American markets. The reverse listing scams. The lack of accounting principles. China stripping assets out of tech winner after tech winner in the past couple years. 

So, where does that put me with China? To me it is a purely speculative trade. Investing in Chinese companies is not an investment in my mind. I have taken every company off of my list except Alibaba (BABA) because I think it is the best company in the pack due to its growing cloud. I don’t invest in it though. It’s there to be watched. 

What am I watching for? I am watching to see if prices get so low that it becomes likely that Xi actually takes some pressure off in order to lure more western money into China. That’s the reflexive trade. 

There are two ETFs I am interested in if I make that trade. 

The first is the Emerging Markets Internet & eCommerce ETF (EMQQ). It is about half Chinese stocks. 

EMQQ Holdings
EMQQ Holdings ( )

This fund is representative of the leading growth sectors of the economy. If China and other emerging markets simultaneously near bottom prices AND I want China in the first place, then this is a good blended fund. It has been a top performer versus peers. 

The next fund is a pure play on China tech, which is where I want to be since it is the one that the government has both meddled with and most needs to lure money back to China. The KraneShares China Internet ETF (KWEB) has about half of its holding in its top 10 stocks, including Alibaba at number four and about 6%. 

Finally, another idea for China is simply to buy Alibaba if you ever believe China is a place to invest again for a while, that is, while they are sucking in western money for a while. Alibaba I believe is hands down the best company in China for a number of reasons, including its growing cloud business. I’ll discuss it more in depth when I think Xi is likely to have a reflexive pivot. 

For now, I am still avoiding all Chinese exposure, including ETFs. Take that as I have no GTC orders on EMQQ or KWEB at this time. If that changes, I will let you know the day it does. 

The Rest Of Emerging Markets

For now, in the face of a Federal Reserve that is poised to raise rates for at least a while – I think it will less and not as long as most think – I am avoiding other emerging markets as well. 

Of those high on my list are India, Brazil, Mexico, Vietnam and Malaysia. Each has its own strengths per my list, and particular risks per my list. We will need to look for moment in each when fallible backwards looking narratives begin to give way to reflexive pivots to brighter days. 

A dollar that stops rising, at least for a while, will be a period when emerging markets can do well again. From that, you should infer, that we will be position trading these ETFs for a few quarters to a few years at a time. 

I will break down an emerging markets list of ETFs in the next couple months as we see what Fed policy and the economy are likely to bring us, and in the face of the many equally loud and uniformed narratives we will be subjected to.