Emerging Markets, Not for The Faint of Heart

I am a believer in an allocation to emerging markets—stocks not bonds—but it is certainly not for the faint of heart and even there is an economic/investing  long term rationale for holding them due to risk tolerance in terms of short term movements many investors should simply not own this asset class.

Emerging Markets are a perennial source of “hot money” flows buying at the top and selling at the bottom in performance chasing,.  Add in the short term traders and you have extreme volatility especially on the downside.

So this shouldn’t be a surprise from index universe.com

[Hot ETF Topics]

EEM Bleeds Assets As Global Markets Falter

Investors this week have yanked $3 billion out of the iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM), as well as money from other ETFs that canvass relatively risky pockets of the investment universe, such as high-yield debt, amid heavy selling in the past few days, especially in Japan.

Here’s a chart of EEM the emerging market stock index ETF, note the extremely high volume (scale at bottom of chart) of late and the massive spike in volume at the 2008 low…clearly this is not for the faint of heart…

Also of course one can see the big chains up through the recovery from the 2008 carsh and a disappointing recent 4 years especially compared to the SP 500

Here is the emerging markets index in green EEM) vs the S+P 500 (in blue SPY)for 10 years the growth of $100,000 investment. In other words $100,000 grew to $350,000 in emerging markets vs. $200,000 for the S+P 500

On the other hand here are  is the same comparison over the last 5 years $100,000 grew to $200,000 in the SP 500 and emerging markets did basically nothing.

Valuation Matters…In The Long Term

Of course such a large disconnect in price change creates a divergence in valuations as well.

The recent market declines in emerging markets and continued relative strength in the US market make emerging markets look quite reasonable relative to the US in terms of valuation

. Emerging markets ETF IEMG carries a p/ of just under 11 while the S+P 500 is trading at just under 15. If the bullish case for the US market is based at least in good part on potential for exports by US companies to the emerging markets…it’s hard to rationalize a decline in emerging markets because of weaker prospects for economic growth…somebody has it wrong or at least is looking short term and chasing momentum and recent market performance.

According to this article published by Bloomberg after the market close on  June 14 this low valuation has caught the eyes of some investors, Although I would be loathe to find a specific reason for a one day market move. If emerging markets move down in the next week it will hardly be related to a changed view of valuations. But the article does give an interesting relative measure of valuations.

Emerging-Market Equities Rebound After Valuations Slump

…The MSCI Emerging Markets Index added 0.6 percent to 1,008.92 in New York, after slumping the most since July yesterday. The decline drove the index down to 1.5 times net assets, compared with 1.9 for the MSCI World Index, the biggest gap since August 2005, according to data compiled by Bloomberg. ….

In my view price can deviate from value in the short term but in the longer term price reverts towards value. An article in the weekend WSJ  by Jason Zweig entitled

The Intelligent Investor: Why the Markets’ Latest Stumbles Are Good News

included the following observations on emerging markets with a similar view on valuations.

…..funds that invest in emerging-market stocks ($16.2 billion in over 20 weeks, $7.8 billion out in 15 days), emerging-market debt ($3.8 billion in, $999 million out) and Japanese stocks ($13.6 billion in, $437 million out), among other categories.

“As I visit clients world-wide, almost every single investor tells me the same thing,” says Brian Singer, who runs the $145 million William Blair Macro Allocation Fund, which invests in a variety of assets around the world. “The only place they’re seeing any opportunity is in the U.S.”

He adds, “If it’s the global consensus, you can be pretty sure it’s priced in”—meaning that the wise investor should shop beyond U.S. stocks.

Mr. Singer thinks stocks in Europe and in emerging markets have gotten much more attractive in the recent selloff. He projects future returns of up to 14.5% annually over the next eight years on European stocks (and at least 20% in the Italian and Spanish markets) and 11% on emerging markets.

U.S. stocks are at a price/book ratio—or market value relative to corporate net worth—of 2.3, or more than 10% higher than they were at year-end, calculates Ryan Larson, a vice president at Research Affiliates. The same ratio on emerging-market stocks has fallen below 1.5, from 1.6, making them more than one-third cheaper than U.S. stocks.

Over the same period, the dividend yield in the U.S. has dropped to less than 2.1% from 2.2%, even as the yield on emerging markets has risen to 2.9% from 2.7%.

It's Usually No" Different This Time"

Among the strategies/products proposed and adopted among many investors in the search for yield have been alternatives to investment grade US dollar bonds in the treasury or corporate bond market.

Here are ETFs of categories that have been high on the "alternatives to generate income" list.and their returns since May 1


EMB and EMLC emerging markets bonds
PFF Preferred stock
PFM Dividend  Achievers Stock ETF
PFF Preferred Stocks
VNQ Reits

The traditional " strategy to insulate a portfolio from rising rates is to shorten maturities. Below are returns the same period for
SHY short term US treasuries
VGSH short term US Govt bonds
VCSH Short term investment grade bonds
SJNK Short term high yield bonds

As The Bond Market Turns...Investors Show They are A Fickle Bunch

I  was never a fan of Pimco Total Retun Fund when it was just a mutual fund and its new ETF option hasn't changed my mind although at least the management fees are much lower.. My problem isnt the manager Bill Gross but the fact that as a 'go anywhere, do everything fund it can be anywhere (including out of ) the bond market. So you are counting on Bill Gross not getting the returns of the bond market as a whole. For the simplest way to postion a bnd allocation AGG the total bond market index merits a good look. At least you wont underperform the bond market.

Based on recent performance this 'a surprise to me

The Pimco Total Return ETF (NYSEArca: BOND) broke its impressive asset-gathering streak with its first monthly outflows ever in May. Those losses have been compounded by BOND bleeding $119 million in the first five days of June.

Some Good Advice on Long Term Investing from the Pages of the Wall Street Journal

here

Volatility Isn't the Enemy

Once investors accept that volatility isn't the enemy, advisers should focus on two things to help them stay comfortable in the market. First, make sure clients have enough liquidity to meet their needs through downturns, so they don't have to sell when the market bottoms. Second, make sure they're comfortable with their portfolio's assets and allocations. That way, clients won't be tempted to sell in a panic if the market turns down.

Investors and advisers should also make sure that portfolios are truly diversified. Looking at the asset-class breakdown may not tell the whole story. For example, an asset class called hedge funds may actually be highly correlated to equity markets and not all that different from other investments.

and here

Voices: Larry Swedroe, on Overvaluing Growth Stocks

Investors have two problems. The first is that they love assets that look like lottery tickets–the ones with the potential to be a home run. They want to buy into the next Google. That preference has led these stocks to have prices that are too high, and historically that has led to lousy returns.

The second problem is that investors typically fail to understand that reversion to the mean for growth stocks is quicker than people anticipate, so growth doesn't last long. People end up overpaying for growth because they don't understand how rapidly excess earnings can disappear. Knowing this, advisers should direct their clients to a portfolio that takes this into account, fits their individual situation and doesn't overvalue growth stocks.

This Shouldnt Really Be Much of A Surprise

Looking at this chart of investor flows into equity mutual funds:

...and this chart of the sp 500

I dont find this particularly surprising:

Look Out Below: ‘Thundering Herd Is Moving the Wrong Way’

Seems like that thundering herd that fueled the massive inflows into stocks thus 

far this year are having second thoughts:

“Our clients just aren’t convinced that even some moderate to soft economic news is going to keep the Fed from paring back its policies,” Bliss said. “They’re getting nervous about staying long this market after such a big rally.

“The thundering herd is moving the wrong way. They’re taking some chips off the table to re-evaluate their positions.”

which creates a shorter term chart that looks like this

Emerging Markets Bonds Not A Great Asset Class to Choose in the Search for Yield

From Bloomberg

Turkish Yields Surge Most on Record as Protests Hit Lira, Stocks

The yield on benchmark two-year lira bonds rose 71 basis points to 6.78 percent, the biggest jump since at least April 2005 when Bloomberg began compiling the data. The benchmark stock index plunged 10 percent, the most in a decade, and the lira weakened for a fifth day, sliding 0.8 percent to 1.8903 per dollar at 5:30 p.m. in Istanbul, a 17-month low.

The  largest (by assets) emerging markets bond funds is EMB is has a

6.8% allocation to Turkey, price decline since May 32 is 3.6%  current yield 4.35 so most of the yield has been wiped out (in total return )in a week

EMB now has a total return ytd of  -5%

SJNK short term high yield has a similar yield it's risk and return are compared to EMB below.

I have written before that Emerging markets bonds whether denominated in dollars or especially if denominated in foreign currency are a poor choice to pick up yield given the additional risks vs dollar bonds and suggested looked at domestic high yield bonds, particularly low duration as an alternative.

wsj website June 5

Investors baffled by Turkey Protests

Some Gleanings from the WSJ of the Last Few Days

I think I can remember the last time I saw a headline like this...it didnt't end nicely WSJ May 31
The 100% Stock Solution

....and so much for taking advice from a professional in a newspaper for your asset allocation. I dont have time to go through all my objections to a portfolio like this and I dont want to beat up too much on a colleague.. But the advisor has apparently bought into the latest" it's different this time" mantra "bonds as a substitute for stocks". As is usually the case this works for awhile and the outcome ultimately is not pretty. Stocks are not bonds or a substitute for them.

I have been expecting this for quite awhile..and it could be just the beginning.

Dividend Stocks Fall Victim to Fed

Utilities, REITs, Other Sectors That Benefited From Aggressive Bond-Buying Program Take a Hit

Stock investors are getting a taste of what could be in store with a sustained rise in bond yields.

A month of sharply climbing U.S. Treasury yields culminated last week in an abrupt selloff among stocks that had been posting big gains thanks to demand from income-hungry investors.

Hardest hit were utilities, telecommunications stocks and real-estate investment trusts, all of which had benefited from the Federal Reserve keeping government-bond yields at rock-bottom levels. The Fed's extraordinary stimulus policies, which have pumped billions of dollars into the financial markets, had caused investors to seek out income in riskier fare, such as stocks that pay high dividends.