Rebound in Non US Markets

Emerging markets and European markets suffered large declines in the last 3 months in response to a litany of perceived problems: Turkey's currency and debt crisis, potential for trade wars, and sharp declines in markets in Argentina and Mexico. As can be seen in the charts below the selloffs were marked by large increases in volume at the low points with an extreme spike in volume at the mid August low. This is typical of non US markets, particularly emerging markets where there is considerable performance chasing. All of these declines occurred as the US markets were hitting record highs.

FEZ (Europe) YTD performance...not volume spikes (bottom scale) at the lows

IEMG Emerging Markets (note volume spikes at market lows)

The divergence in performance between emerging markets and the S+P 500 was the largest in over a decade.

Below is a 2 year chart of IEMG(emerging markets) FEZ(Europe) and SPY S+P 500 as can be seen the large divergence in performance between US and non US markets began in May as "headline risks" had impact on the markets.

This divergence in performance has created large valuation gaps between US and non US markets:
                                             


                                              p/e                         dividend yield


IEMG emerging markets       13.81                        2.66%
FEZ Europe                            15.09                       3.16%
SPY S+P 500                         23.45                        1.84%

Perhaps in reaction to a bit of a fading of the concerns mentioned above and the large divergence in the valuation measures non US markets have has a sharp rebound in the last two weeks perhaps overlooked as US markets keep moving to new highs: Most recently Europe has shown more positive economic surprises than the US and there are signs Germany will step in to give financial assistance to Turkey.

In the last 2  weeks IEMG has rallied 2.4%  FEZ 3.8% vs. a rise of   2.1% for SPY. The non US ETFs are still negative for the year IEMG -6.2 and FEZ -1.4% far underperforming the SPY rise of 9.6%.
Given the gaps in performance and valuation perhaps the recent moves are signs of closing of the performance gap between US and non US markets.

High Yield Bonds in Your Portfolio ?

High Yield bonds have proven to be an attractive addition to portfolios. They are not for the faint of heart however since they can be subject to large down years far in excess of those for investment grade. In fact, they have near zero correlation to Treasury bonds--not surprising since Treasury bonds benefit and high yield bonds take big losses during periods of extreme financial market uncertainty and the "flight to quality".

Their risk measures fall somewhere between stocks and treasury bonds and they have a relatively high correlation to US stocks. Nonetheless they show some attractive risk/return characteristics.

Ten Year data these include the worst year for high yield bonds in the last 20 years--2007 when high yield bonds fell 31%.

10 year returns Bond ETFs Hyg high yield gold vcit intermediate corporate green AGG aggregate US Bond (blue) VGIT Intermediate Corporate (Black)

There is considerable reversion to the mean in spreads (differentials) between high yield and investment grade bond yields with periods of financial crisis leading to the flight to safety and sharp widening of yields--as can be seen in the extreme move during the 2007-2008 financial crisis. Current spreads are low reflecting confidence in the US economy and low perception of financial risk.

 Investors looking to add high yield to their portfolios might consider a lower duration high yield bond ETF like SJNK which reduces duration risk=sensitivity to changes in interest rates. As can be seen below (SJNK short term high yield in green HYG intermediate term high yield in blue) during the last 2 years of rising rates short term has outperformed.

How is "Smart Beta/Factor Investing" Doing ?

We now have over 5 years of data of live trading from the ishares "smart beta/factor" ETFS VLUE(Value), MTUM (momentum),QUAL (quality) and USMV (minimum volatility).

Momentum has shown the most outperformance vs the S+P 500. But all of the ETFs have shown impressive results VLUE and QUAL have also outperformed the S+P 500 (SPY) with little or no increase in volatility and USMV has performed very much in line with its target : slightly lower return than SPY with considerably lower volatility. It is not surprising that in a market dominated by momentum, value would outperform.

5 year return Mtum(black) qual(green) USMV(blue),Vlue(gold),SPY(S+P 500 red) 

An equal weighted portfolio of the smart beta ETFs outperformed the SPY.Although the volatility was higher the increased return was far in excess of the added volatility The portfolio generated "alpha" the most widely used measure of portfolio perfomance.

EQUAL WEIGH SMART BETA ETFS (green) S+P 500 (blue)

Of course five years is too short a period to draw definitive conclusions and the results are someone skewed by the large outperformance of momentum during a massive bull market, yet the results are impressive.