Investors this week have yanked $3 billion out of the iShares MSCI Emerging Markets Index Fund (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.
Indeed, the Nikkei fell almost 6.5 percent on Thursday, as concern about the possibility of rising interest rates globally sparked selling of riskier assets, and brought the yen’s historical role as a safe-haven currency rushing back to the fore. That, in turn, has sparked outflows from yen-hedged ETFs such as the WisdomTree Japan Hedged Equity Fund (DXJ), the best-selling ETF in 2013.
The contradiction at the center of the sell-off is that the U.S. economy continues to show signs of a slow and steady recovery. But it’s precisely that type of good news that raises the possibility of the beginning of the end of the Federal Reserve’s ultra-easy monetary policy that has prevailed since the crash of 2008. The prospect of higher borrowing rates, in turn, engenders fears in both stocks and bonds.
The benchmark 10-year note is hovering around 12-month highs at about 2.2 percent, up from about 1.64 at the beginning of May amid some Fed talk that the easy-money era may be growing long in the tooth, particular in view of data such as the latest weekly first-time jobless claims, which came in Thursday at a five-year low.
U.S. stocks rose on the news, largely unaffected by Japan’s sell-off, with the S'P 500 Index ending nearly 1.5 percent higher on Thursday. On Friday, the S'P was down about 0.35 percent as the shakeout continued.
In that context, EEM has bled about $3 billion in assets under management this week, according to data compiled by IndexUniverse—a sign investors are worried that growth in the developing world might be hurt if higher rates come to pass.
Interestingly, the Vanguard FTSE Emerging Markets ETF (VWO) has lost no assets in the same period, a reflection of the buy-and-hold bias of many Vanguard clients compared with those who hold EEM, which are more often institutions.
Bond ETFs have also suffered redemptions in recent days, with the iShares iBoxx $ High Yield Corporate Bond Fund (HYG) losing about $230 million in assets in Wednesday’s session alone. Junk bond prices are likely to fall relatively sharply compared with other bonds, as they are riskier.
Japan And DXJ’s Challenge
The dynamic in global markets is, of course, a bit more complicated than just a strong U.S. economy creating head winds, though that is a big driver.
On May 22 of last month, for example, Fed Chairman Ben Bernanke indicated that quantitative easing may begin to be curtailed late this year. That was the same day China coincidentally reported unexpectedly weak data on its growth.
Those two factors were enough to send the Nikkei down 7.3 percent which, in turn, pushed yields on benchmark Japanese government bonds up to a 1 percent threshold.
That threshold is something of an abyss, to the extent that beyond it, the cost of financing Japan’s huge budgetary deficit starts to look problematic, even untenable.
At that point, Japan’s sell-off was both the tail being wagged by the U.S. and China, and the dog wagging the rest of the economy. Indeed, U.S. markets followed suit with a sell-off the next day, though the selling wasn’t nearly as sharp as it had been in Japan.
Still, the lasting effect of that day is a nagging sense that the difficulties Japan may face trying to weaken its currency and thereby pump up its export sector might end up being significant. To date, most of the yen’s weakening has been a function of Prime Minister Shinzo Abe’s pledges about doubling Japan’s monetary base.
“So much of this has been fueled by this ‘shock and awe’ campaign by Abe,” IndexUniverse ETF analyst Dennis Hudachek said. “How much more can they do?” He stressed that actual policy moves that would truly help address structural issues that have kept Japan’s economy in a low-growth mode for nearly 25 years haven’t yet materialized.
The yen has fallen almost 9 percent this year against the dollar, but it was down by nearly 20 percent about a month ago, judging by movements of the CurrencyShares Japanese Yen Trust (FXY), a long yen-dollar cross in an ETF wrapper. The fund has risen more than 7 percent in the past month.
More to the point, the astonishing flows into DXJ, the WisdomTree fund that protects U.S. investors from a weakening yen, have slowed in recent weeks and even reversed.
The fund crossed the $10 billion threshold last month by dint of an industry-leading $7 billion in inflows and rising Japanese equities markets.
But in the past few weeks, the fund’s assets under management have dipped due to outflows and a falling share price. The fund has bled almost $300 million and its assets are at just over $9.2 billion and its price has fallen by more than 10 percent in the past month.
Also, in Wednesday’s session, DXJ’s unhedged competitor, the iShares MSCI Japan Index Fund (EWJ), suffered redemptions of about $230 million, with its assets ending the day at $11.31 billion, according to data compiled by IndexUniverse.
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