Energy, Commodities and Emerging Markets

Having never owned the Emerging Markets (EM’s) in any form or fashion in the 1990’s and then staying out of the asset class between 2001 – 2007 given all the money that flowed into the asset class after Technology collapsed, Emerging Markets were bought for clients early in 2016, when the 10-year return on EM’s went negative, and 7 years into the SP 500 bull market.

The other aspect to this trade was that with Energy and Commodities bottoming in Q1 ’16, whether rooted in statistical rigor or not, there always seemed to be a correlation between rising commodity prices and the out-performance of EM’s.

The point to today’s blog post is that while watching the very weak price action in crude oil, nat gas and copper this week, Emerging Market’s including Brazil, actually had a good week. In oter words, some EM and EWZ weakness was expected this week, watching the commodity trade, and instead the opposite happened.

This article may be the reason:

It is tough referencing any investment article with the word “hot” in the title, but readers should get the point, Since President Trump came out and actually said he preferred a weaker dollar (unusual for a President to comment on the dollar since the dollar and its relative strength and weakness is usually the purview of the Treasury Secretary), the EM’s have been relatively stable,

YTD returns of SP 500 and EM ETF’s: 

  • SP 500: 6.88%
  • VWO: 11.37%
  • EEM: 13.43%
  • EWZ: 9.08%

Here was the first article on EM’s last year referencing PIMCO’s outstanding call on the asset class, and then again here in the last few months.

Here are longer-term charts on the EEM, VWO, EWZ:

Click to enlarge

Fundamentally, Brazil is moving (slowly) closer to labor reforms, and embracing more free-market policies, plus interest rates are coming down from mid-teen’s levels. The country was the poster child for everything that was wrong with the EM’s the last 10 years: corrupt socialist leadership, economy tied to commodity prices, high interest rates, etc. etc.

The largest holdings of the EWZ currently at 20% of the ETF are two Financial stocks, with Petrobras down at 5% in the 4th position. This gives me a little more comfort in terms of crude oil price action.


Click to enlarge

The EEM is the iShares ETF. The top 3 holdings are South Korean’s Samsung, China’s TenCent and Taiwan’s Taiwan Semi, so readers have two large-cap Tech companies with about 9% of the market cap of the EEM.


Click to enlarge


The VWO is Vanguard’s ETF and its largest holdings have smaller weightings than the EEM and one of its top 5 holdings is a South African company. the other four companies are China and Taiwan domiciled.


Analysis / conclusion: 

These are monthly charts of the asset class. Brazil is probably the closest to a longer-term break of the downtrend line, which would be a positive technical signal for the ETF.

Tax reform in the US and a rapid strengthening of the US dollar probably would throw a wet blanket on the EM’s.

A return to global growth as we are starting to see in Europe would be a positive,

Warren Buffett commented this weekend at Berkshire-palooza that China’s stock market was cheaper than the US stock market right now, if the headline captured his statement accurately. The EEM ETF probably gets readers a little more China exposure in the yop market cap weightings than the VWO. I do like the Vanguard ETF given its low cost.

Here are my closing thoughts for readers:

1.) Wait for a clear break of the longer-term downtrend lines if you are worried about the asset class.

2.) Dollar strength will matter if the Republican fiscal policy objectives are achieved. Remember the USD index all-time-high is up around 124. At 99 today a mild strengthening of the US dollar probably would not impair the EM trade if global growth improved with with it.

3.) Personally, being the world’s 2nd largest economy, I dont know how China can be considered an “emerging market”. But it gives client’s a “reversion-to-the-mean” trade given its 10-year shellacking, and it’s one vehicle that does not own Apple, Facebook or Amazon (long all 3.). (Bad attempt at sarcasm.)

Thanks for reading.





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