Emerging Market ETFs Rally in Spite of Trump Trade Threat

In the wake of Donald Trump’s election, emerging-market ETFs tumbled as investors feared that the new administration’s protectionist trade policies would hurt the countries in these markets. But then a funny thing happened. After ranking as one of the worst-performing sectors in the last quarter of 2016, emerging- market ETFs began the new year with a rally and are outperforming U.S. stocks.

So far this year, Vanguard FTSE Emerging Markets ETF (VWO) has jumped 10%, iShares Core MSCI Emerging Markets ETF (IEMG) leapt 10%, and the iShares MSCI Emerging Markets ETF (EEM) climbed 10% vs. 5% for the SPDR S&P 500 (SPY).

Part of the reason is that prior to the election, 2016 had been a pretty good year for emerging markets. Because many emerging markets are tied to commodities, the prior four years had been pretty bad because of falling commodity prices and slowing growth in China. But in 2016, commodity prices began to rise and China’s economic slowdown stabilized.

A big part of the postelection drop was out of concern for the economy of Mexico should Trump attempt to renegotiate Nafta and anxiety over trade barriers with China, according to Mitch Tuchman, chief investment officer at Rebalance IRA, a retirement investment advisor, in Palo Alto, Calif.

Robert Johnson, Morningstar’s director of economic analysis, said the recent performance is a continuation of last year’s rally. He also said companies and investors have begun to think that, in the wake of Trump’s mishandling of the immigration ban, he might not be able to implement his trade policies, especially as he gets pushback from industries hurt by trade bans and tariffs.

Also, since the trade policies haven’t yet been defined and investors think most emerging markets, besides Mexico and China, won’t be affected, they’re jumping back in.

“After five years of underperformance, emerging markets were oversold, and the election flushed out the remaining people hanging on,” said Gerald Laurain, chief investment officer with FTB Advisors, an RIA in Memphis, Tenn., with $4 billion in assets under management. “So now that they’ve established a low, the only place to go isup.”

J.J. Feldman, a portfolio manager at Miracle Mile Advisors, a Los Angeles-based RIA, said the valuations are much more compelling. The price/earnings ratio on the emerging markets is 12 vs. an expensive 18 on the S&P 500. He added that emerging- market stocks are yielding 2.25% vs. the S&P’s 2%.

Peter Schiff, CEO of Euro Pacific Capital, an asset manger in Westport, Conn., has a different angle. “When there is protectionism, America is the loser,” he said. “And tariffs will backfire. People are making the connection that it will weaken the dollar. Meanwhile, the euro is bottoming out and that is better for emerging markets.”

“Europe seems to be doing better, and it’s more important to China than the U.S.,” said Johnson. “There’s better growth there, no new rules and other markets they can sell into.”

So far through this year, the top country-specific ETFs are all in emerging markets. IShares MSCI Brazil Small-Cap (EWZS) has soared 30%, VanEck Vectors Brazil Small-Cap (BRF) surged 26%, iShares Brazil Capped (EWZ) is up 18%, Global X MSCI Argentina (ARGT) up 16%, and KraneShares CSI China Internet (KWEB) up 16%.

After a brutal two-year recession in Brazil, during which President Dilma Rousseff was impeached and replaced by Michel Temer, the country is finally expected to be on the road to recovery. Finance Minister Henrique Meirelles expects the Brazilian economy to return to a 2% annual growth pace by the last quarter of the year. Wall Street is forecasting a more realistic 0.2% growth rate in 2017 gross domestic product. Brazil’s economy is driven by resources and commodities. Its top commodity exports are oil, iron ore, soybeans, sugar cane and coffee.

While China is seeing its economy slowing, with GDP expected to post growth of 6.7% for 2016, that’s the kind of slowdown most country’s would kill for. Right now China is dealing with a cooling housing market, explosive growth in debt, and painful structural reforms instituted by President Xi Jinping.

“E-commerce is going well and that is tapping into a strong part of the economy,” said Rob Lutts, president and chief investment officer of Cabot Wealth Management, an RIA, in Salem, Mass. Lutts spends a lot of time traveling in China. “Investing in Alibaba is like investing in Amazon.com.”

Lutts said that China will have a big challenge over the next five years with a big debt bubble that will have to be distributed over the rest of the economy. This will bring the economic growth rate down to 5% by 2020. “They will have stress when the real estate bubble comes down in price, and that will hurt the smaller banks in the next six months.”

But Lutts is very bullish on India. For the fiscal year ended March 2016, India’s economy grew 7.9%, and Lutts said it could go higher. Indian Prime Minister Narendra Modi is instituting reforms to remove government obstacles to business and make the government more efficient. Lutts said his favorite way to invest in India is in the financial services sector.

He thinks HDFC Bank is one of the best-managed banks in the world. It’s also the top holding of iShares MSCI India ETF (INDA), No. 3 in WisdomTree India Earnings Fund (EPI), No. 2 in iShares India 50 ETF (INDY) and No. 3 in PowerShares India Portfolio (PIN). The ETFs’ year-to-date gains range from 8.8% to 9.8%.

Overall, all the experts think that because Europe is growing and Trump’s policies are still undefined, emerging markets should keep rising throughout the year.

Orginally published in Investor’s Business Daily.

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Can China ETFs Continue Their Ascent?

China ETFs’ recent gyrations are enough to give one whiplash. Many have behaved like the Shanghai Composite Index recently. After soaring 152% over the previous 12 months — 60% this year alone — to a seven-year high on June 12, the benchmark for mainland China’s stock market hit a significant speed bump.

Last week the index stumbled 13% into a much-anticipated correction. A 5% rally the first three days of this week gave way to selling Thursday, cutting the week’s gain so far to 1%.

“The sheer increase in prices this year is something that makes me want to stand back,” said John Rutledge, chief investment strategist for Safanad, an investment house in New York. “I don’t know any fundamental reason why prices should have doubled this year, and that price behavior sounds like a bubble.”

Rutledge is referring to the fact that the Chinese economy’s growth rate has slowed to a six-year low of 7%. But if fundamental analysis can’t explain it, macroeconomics can. With central banks all over the world cutting interest rates, there is flood of liquidity looking for returns.

The first thing to know is that there are two markets in China. The Hong Kong market, which has long been open to global investors, trades what are known as H-shares. Then there are the mainland markets in Shanghai and Shenzhen. They trade A-shares, which had been limited to domestic investors.

But last year the Shanghai and Hong Kong markets created a system that let global investors buy A-shares and domestic investors buy H-shares. This change has brought a lot of money to the mainland markets.

On top of that, the People’s Bank of China, the country’s central bank, has cut interest rates three times since November, and more cuts are expected.

Finally, throw in a slowdown in the Chinese real estate market. It led the Chinese government to encourage investments in stocks by making it easier for Chinese retail investors to open accounts and buy stocks on margin.

Loss Of Liquidity

And a loss of liquidity sparked last week’s correction. First, Chinese regulators, worried that the market was getting overleveraged, tightened the rules on margin trading. Then a slew of initial public offerings sucked up a lot of cash.

There’s no doubt that China is risky. But gains could resume if the economy picks up and government stimulus programs continue. And index provider MSCI is evaluating A-shares for inclusion in its emerging markets index. That could spark demand by many funds that track MSCI indexes.

If you want China A-Shares in your portfolio, investing in ETFs is the way to go. KraneShares offers four ETFs focused on China. Its Bosera MSCI China A ETF (ARCA:KBA) holds more than 300 large-cap and midcap stocks on both the Shanghai and Shenzhen stock exchanges.

KraneShares says that these are the stocks that would be included in an MSCI emerging markets index. KBA is up 40% year to date and 126% in the past 12 months. It has an expense ratio of 0.85%.

Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ARCA:ASHR) tracks the CSI 300 Index, which holds the largest and most liquid stocks in the A-share market. It’s up 35% year to date and 129% for the past year. It charges 0.8% of assets for expenses.
Market Vectors ChinaAMC A-Share ETF (ARCA:PEK) also tracks the CSI 300 index but charges less: 0.72%. It’s up 39% year to date and 132% in the 12 months. The big difference is that ASHR is more liquid and offers a 0.2% yield, while PEK offers none.

As liquidity improves in July, David Goldman, managing director of investment firm Reorient Group, sees a market recovery and a move back up beyond the 5,000 level for the Shanghai Composite.

“Economic fundamentals are clearly improving, and so are regulatory incentives for stock market growth,” he wrote this week.

Originally published in Investor’s Business Daily.

Investor cash pours into Hong Kong ETFs

All this talk about a bubble in the Chinese stock market isn’t scaring away investors from flooding the largest exchange-traded funds that track Chinese stocks with bucket loads of cash.

April saw HK$20.5 billion ($2.6 billion) flow into the Hang Seng H-Share Index Fund (SEHK STOCK CODE 2828). It was the largest monthly inflow since 2010 and the third-most among equity ETFs globally, according to data compiled by Bloomberg.

The Hang Seng H-share ETF holds the stocks of 40 of China’s biggest state-owned companies. Financials make up 67% of the portfolio. The fund is valued at about 10 times forward earnings, compared with the 17 multiple on the Shanghai Composite Index, according to Bloomberg.

The ETF’s shares rose 17% last month to HK$145.20, its third consecutive month of gains. Over the past four months, the ETF has received a total of HK$29 billion, its longest stretch since 2013. Total assets grew to HK$57.1 billion.

The U.S.-listed iShares China Large-Cap ETF (FXI) received $385 million last month, the biggest inflow in eight months. It jumped 16% in April, for a 51% return over the past 12-months.

One big reason for the rally is that Chinese companies trading in Hong Kong are priced at a significant discount to their dual-listed counterparts on the mainland. UBS said even though the Hang Seng China Enterprises Index leapt 17% in April, its largest jump since October 2011, Chinese A shares still trade at a 31% premium to Hong Kong stocks.

Investors are betting on more monetary easing in the world’s largest economy.  Since the November Shanghai-Hong Kong exchange link opened mainland stocks to foreign investors, mainland stocks have seen a flood of inflows. In addition, the People’s Bank of China has cut interest rates and reduced banks’ reserve requirement ratios twice in the past six months, sending more liquidity into the markets. Another rate cut is expected soon.

Over the past year, the Hang Seng China Enterprises benchmark soared 48% vs. the 119% surge of the Shanghai Composite Index’s A shares.

Originally published in Asia Times.

Schroders Says Buy European Equities

he European economy will continue to be sluggish in 2015 leading to the potential for political unrest, said the experts at Schroders, the giant British asset manager. However, European equities should do well in spite of this.

Meanwhile, Japan should see benefits from a weaker yen, but this will hurt other Asian economies.

The 200-year old firm, which manages $448 billion in 27 countries, presented its market view to the press last week in London.

Keith Wade, Schroder’s chief economist, said falling commodity prices will drive inflation lower, and the declining euro will stop deflationary pressure in the euro zone.

Wade is bearish on the Chinese economy, but he doesn’t expect a hard landing. Meanwhile, emerging markets continue to struggle because of the Chinese slowdown.

“A lot of headwinds are being lifted in Europe and that should help growth,” said European economist Azad Zangana, pointing to the weaker euro. Still, he remains cautious.

Rory Bateman, head of European and U.K. equities, agreed Europe’s economy will be sluggish, but that equities will do well. A weaker euro should help corporations deliver earnings growth between 3% and 5%. Falling oil prices will also help earnings. Bateman expects European financials to post double-digit earnings growth.

Still, with high unemployment across the continent, there is high potential for political unrest. Zangana doesn’t expect major upheavals, but still enough to worry investors.

Bob Jolly, head of global macro, said the high unemployment is increasing the popularity of extreme political parties, with potential flashpoints in Spain, Ireland, Germany and Greece.

Steven Cordell, who manages European equity funds, blamed the European recession Ukraine and Russia. He expects a slow protracted recovery. The German economy is suffering from sanctions against Russian companies and the downturn in China, two major export partners. Cordell agreed that the European banking system is now healthy. He said banks can access cheap capital at a 0.05% marginal lending rate from the European Central Bank.

While the credit market reflects the banks’ improved fundamentals, equities don’t. Cordell said 61% of European companies have better dividend yields than bond yields. This tells him the problem is in bond valuations, not equities. He said it’s a good time to buy European stocks because dividends are at their peak yield in excess of bond yields.

Exporting Inflation

As for Asia, emerging markets economist Craig Botham said while Japan’s policy of devaluing the yen makes Japan’s exports cheaper, Japan is exporting inflation to other parts of the region, like South Korea and China. Botham added that Asia is one of the best-placed regions to benefit from a U.S. recovery, when U.S. consumers buy more electronics and consumer durables.

James Gautrey, portfolio manager for global equities, said that by the end of next year the number of people accessing the Internet from mobile devices in India and China will exceed 1 billion. The way to make money is buy telecoms in India and Internet companies in China.

“I think Alibaba is very underrecognized,” said Gautrey. “Its take rate is 2.3% compared with the 12% done by Amazon.”

Originally published in Investor’s Business Daily.

China Stock Market: Decline Presents Opportunity

The Tiananmen Square massacre, in which Chinese troops killed hundreds of pro-democracy protesters, occurred 25 years ago last week. While the Chinese government didn’t give their people democracy, it did give them capitalism.

Just 18 months after the massacre, in December 1990, the government opened the Shanghai Stock Exchange.

Since then, China has become one of the world’s fastest-growing economies. According to the World Bank, the per capita growth of China’s gross domestic product since Tiananmen Square is 8.8% on an annualized basis.

“While the Chinese government reacted harshly to the protesters in Tiananmen, it’s made a concerted effort to increase growth and wealth over the past 25 years, which has had a huge impact on the population,” said Jonathan Brodsky, managing director of Advisory Research, a Chicago asset management firm with $11 billion under management.

“The pro-growth initiatives, which have been a powerful tool of the government to maintain stability, were accelerated in the face of Tiananmen.”

Brodsky runs Advisory Research Emerging Markets Opportunities Fund , which has more than 20% of its assets invested in China. The fund was up 9.5% this year going into Monday.

On the 25th anniversary, June 4, 2014, the Shanghai Composite Index closed at 2024, a 1,924% rise from when the market opened. However, even though China posted phenomenal growth over that period, the stock market has experienced enormous volatility on a fairly regular basis. The index is down 66% from its peak of 6092 on Oct. 16, 2007.

Sentiment Sours

Investor sentiment has soured on China for a variety of reasons. Top of the list is that China’s economy has slid from the phenomenal growth rate of 10% a year to the merely great annual rate of 7%. Part of this is related to the declines in the economies of its trading partners in the developed world.

Domestically, the country is suffering from a bubble in the real estate market, a slowdown in consumer spending and high debt levels in the Chinese banking industry. Add to that China’s shadow banking industry, which sells Chinese consumers lightly regulated, obscure investment products, and you can see significant risk to the economy.

Problems Already Discounted?

“The problems are not new and they are fully discounted, maybe more than fully discounted, creating one of the best opportunities to buy China in a decade,” said Jim Oberweis, president of Oberweis Asset Management in Chicago. The firm manages $5 billion in assets, including the Oberweis China Opportunities Fund . The fund gained 60% last year but is down 4.9% year-to-date.

Among ETFs, iShares China Large-Cap ETF (FXI), which holds 25 of the biggest Chinese stocks, currently trades at a price-earnings ratio of 7.6 and a price-to-book value of 1.1, while the S&P 500 has a P/E of 17, according to Morningstar. The fund is down 3% year-to-date, after rallying 5.3% over the past three months.

Global X China Financials ETF (CHIX), which has a P/E ratio of 6, is down 5.9% year-to-date, following a 6.6% rally over the past three months.

IShares MSCI China ETF (MCHI), with a P/E of 9, is down 3.8% year-to-date, after rising 2.3% the last three months.

Originally published in Investor’s Business Daily.

Roubini Says Commodity Super Cycle “Is Over,” but Optimistic on U.S.

For a man nicknamed “Dr. Doom,” economist Nouriel Roubini sounded almost giddy during a recent speech in which he said the reduced possibility of a euro zone breakup has lowered the risk in the global economy.

While the global economy is anemic and still fragile, he said over the next three years growth in the U.S. will be faster than Europe, Japan and China because “the fundamentals of the U.S. are much better in all technologies of the future.”

Roubini, a professor of economics at New York University’s Stern School of Business, received the Dr. Doom moniker after he accurately predicted the 2007 bust in the housing market and the ensuing fiscal crisis in 2008.

But as he stood before a crowd of more than 100 at last month’s Inside Commodities conference, the chairman of Roubini Global Economics said while the U.S. economy remains weak, especially the housing sector, it will get stronger, albeit slowly. Nor does he expect a crash in the bond market.

“How can we create inflation without wage inflation?” he asked the crowd.

He expects the Federal Reserve Bank to begin tapering its policy of quantitative easing and begin raising interest rates by early 2014, which will lead to a gradual strengthening of the dollar. Quantitative easing, or QE3, is the name given to the Fed’s $85 billion-a-month bond-buying program now in its third round. Roubini said by the end of 2017 U.S. interest rates will be as high as 4%.

Yet for the audience of commodity investors, Roubini’s comments were decidedly bad news. He said high interest rates and the stronger dollar will have an inverse relationship to commodity prices.

“The party as we know it is over. The commodity super cycle is over,” said Roubini. “When the dollar gets stronger, everything else being equal, commodity prices begin to fall.” In addition, a slow down in China’s growth will reduce demand for commodities.

The economist said energy prices will gradually lower over time, with oil hitting $90 a barrel, and precious metals will fall too. He predicted the price of gold could fall to $1,000 an ounce by 2015. Rising interest rates and lowered global risk are big reasons for the drop in gold. He also thinks European countries may sell some of their gold stocks to reduce their public debt.

Even though the risk of the European Union splitting has declines, he pointed out that many of fundamental problems there are not resolved. Some countries remain in economic crisis, potential growth is low and the recovery will be “extremely anemic,” between 0% and 1%, which is lethal for the unemployed.

He said the loss of competitiveness in the Euro zone hasn’t been resolved and a fiscal drag remains. The recovery in the Euro zone “will be fragile and always be behind the curve.”

Another big unknown is whether China will have a soft or hard landing. Roubini said China’s growth is unsustainable and its leaders know it. He said the bubble from too much development, housing and investment will fall, along with consumption, and that will bring down growth. He said China’s growth rate at the end of this year will be 7%, sliding to 6% next year and less than 6% in 2015. While not a true hard landing, it will be worse than people expect.

The slowdown in China will cause a drop in demand for commodities which will hurt many emerging market economies. Countries with weakening fundamentals include Indonesia, India, Hungary and Ukraine.

While the prices for all commodities won’t fall for the same reasons, he says geopolitical factors, such as the lowering of tensions with Syria and Iran as reasons for the price of oil to fall. In addition, the balance of supply and demand, will be evened out and prices will decline with new discoveries of oil, as well as the rise of other forms of energy, such as shale. In addition, “the green economy will raise new energy and reduce demand for old energy.”

He recommended that investors be underweight in bonds and overweight in U.S. equities as the economic recovery become more robust and moves into cyclical stocks. He also believes Japan’s economy will succeed under Prime Minister Abe. He said investors should be overweight in advanced economies compared to emerging markets, and that the U.S. and Japan will do better than Europe and United Kingdom.

Fund Manager Sees Little to Fear from Greece and China

I spoke with Christopher Baggini , the senior portfolio manager for the long/short Turner Titan Fund yesterday. He sees the U.S. market moving higher and likes the technology, industrial and health care sectors. However, he’s down on utilities, telecom and basic materials.

As for his view on the macro environment, he says last year’s fears that China will soon be experiencing a hard landing have diminished. He says the sales comparisons for Chinese New Year are up 15% year over year.

While the problems in Europe are already dragging down the U.S. economy, he thinks there is a low probability that a full-fledged Greek default will affect the market. Most of that is already priced into the market and he says that “Greece’s impact is minor to the overall scheme.”

Italy is a bigger problem, says Baggini, but so far it’s not an issue and neither are France or Germany. While Spain has been an issue for a long time, with little money and a high cost of labor, he doesn’t expect it to have an impact in the near term.

Got Them By The Shorts

Barron’s recently examined how the double-leveraged and double-inverse leveraged ETFs out of ProShares, Rydex and Direxion can create startling and distressing results for investors who correctly pick the direction of the market.

In the four months following the end of the Beijing Olympics, the Chinese stock market plunged 34%. Investors who bought the ProShares UltraShort FTSE/Xinhua China (FXP) right after Olympics and held on expected to see a return of 68%. Instead they received a 56% loss.

The devil is in the details. The leveraged funds only guarantee double the return on a daily basis. So, if the fund falls 20% one day and rises 20% the next, the investor isn’t even. That’s because the initial base on the second day is only 80% of the first day’s total. The Barron’s piece, One-Day Wonder, gives a good simple explanation. For more details on how this works, check out Chapter 9 of ETFs for the Long Run.