A Deep Dive Into Emerging Markets

We recommend that investors gain exposure to emerging markets by buying units of the iShares Emerging Markets ETF (EEM), explains Elliott Gue, editor of Deep Dive Investing.

Broadly speaking, the emerging markets outperformed the S&P 500 from 2003 through 2010, underperformed sharply from 2010 until early 2016 and have performed more or less in line with the S&P 500 since early 2016.

A nascent recovery in EEM’s relative strength throughout 2017 was cut short last year amid a 6-month period of significant underperformance between April and October 2018. Equally important, the EEM has significantly outperformed the S&P 500 since late October of last year.  

There are 4 basic legs to our rationale for buying EEM right now:

#1: We’re Bullish on the S&P 500 in 2019

The first point to note here is that there is a strong correlation between returns in the S&P 500 and the Emerging Markets ETF. This history is logical.

After all, when the US market sees strong gains in a single trading year, it’s typically a sign that investors are in a “risk-on” mood and willing to venture into more volatile emerging market stocks. Similarly, in negative years such as 2008 investors are in a risk-off mood and typically favor the safety of developed market stock indexes. 

We remain bullish on the S&P 500 in 2019. We do not believe the US economy is headed for recession nor do we see the S&P 500 entering a recessionary bear market. 

The single most important rationale for buying EEM here is that emerging markets tend to outperform the S&P 500 in years when the S&P 500 produces strong returns. Over the past 20 years, EEM has outperformed the S&P 500 by an average margin of more than 16% in the 8 years when the S&P 500 is up by more than 15%. 

#2: We’re Bearish on the US dollar in 2019

Emerging markets tend to outperform when the US dollar is weak. Our analysis of the past 20 years of data suggests that a combination of a weaker US dollar and positive market returns for the S&P 500 adds up to a powerful driver of emerging markets outperformance. 

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