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Finding a Trend in Emerging Market Equities

In reviewing asset class trends for The Active Asset Allocation Portfolio, I saw a divergence of two asset classes – emerging markets and developed markets. I wanted to explore why this is happening.

We find this to be a rather unique situation, as emerging markets tend to be the more volatile cousin of the developed markets. Emerging market highs are higher than developed markets and their lows are lower. But this time is different. Emerging markets had a brief period where their trends were positive compared to the 200-day moving average but struggle to stay above the moving average for a sustained period of time, while the developed markets continue to their positive trend. They’re not moving together, an unusual occurrence. What’s causing the emerging markets to act the way they are is tough to pinpoint, but below are a few obstacles that could be contributing to their sluggish performance.

Obstacles facing emerging markets:

– The United States is re-gaining a competitive advantage by leveraging technology in manufacturing. This is forcing businesses to reevaluate the cost effectiveness of manufacturing in China and other countries that once had a low-cost connotation associated with them. (Source) and (Source)

– The unintended consequences of currency devaluations are effects that can spill over into other countries. In this case, emerging markets are affected by the currency devaluation happening in developed countries, leading to increased wages and possibly increasing inflation. If the Japanese Yen loses value then its exports become cheaper and more attractive than goods from emerging markets. (Source)

– Exports continue to lag as demand remains low. Developed economies have seen growth in health care, industrials, consumer discretionary and consumer staples, none of which are especially strong industries in the emerging markets. (Source)

Advantages for emerging markets:

– The obstacles mentioned above could be be affecting emerging markets on the short term. Many of the sources listed above remain bullish on this asset class for the long term. Maybe this is a buying opportunity?

– If you look at some of the largest emerging market ETFs, you’ll see about 40% of their holdings are in companies located in China, Brazil and Taiwan. Finding a more diversified security or one that minimizes volatility may be an option to consider, such as a low volatility ETF.

Currently, we see no confirmed trend in the Emerging Markets. The BRIC’s, the largest and most commonly thought of Emerging Markets, have not been performing well for reasons mentioned above. But these are not the only emerging markets in the world. There are plenty of others and some of those may be worthy investments either now and in the near future.

Recap of a Letter Written Before the Election

The following comment was included in the newsletter we sent to our clients at the end of September. It was written during a period where many were unsure how the election would affect their portfolio.

“It’s actually been a pretty good year for most investors. So here we are about 45 days away from the election, and it appears to me, with the recent surge (both US and global), that the markets are picking up steam.

What explains this improvement, considering the dark clouds apparently forming? Could it be possible that the markets would actually strengthen after the election, regardless of who wins it, simply because one huge uncertainty will have been removed? We’re already at the point where, here in the US, corporate earnings, cash flows, cash positions, and dividend yields are all near record levels.

How did this happen when the investor class is full of dread (a looming fiscal cliff or taxmageddon are being discussed by the talking heads all the time)? Can the gulf of relative value between the US bond market and the US stock market, which has been growing almost unabated for 30 years, grow still wider? Or, could it be that John Templeton is right again, and that it is exactly in times like these that bull markets are born?

I don’t discount the volatility that comes with the cyclic nature of the economy, especially one impacted by globalization. The tough months / quarters / years happen for all sorts of reasons and will probably continue. But there are great companies out there that will continue to sell mass quantities of cola, diapers, and the hottest cell phone, and sell those around the world, even if Greece leaves the Euro, or Spain defaults, or if the wrong person wins the presidential election.”