Will Election Hopes Boost The Fragile Five Emerging ETFs?

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The gradual exit of the Federal Reserve from QE has raised concerns about sustainability of the ‘emerging market’ asset class in 2014. The beginning of the end of the cheap-dollar era has led to an uproar in these markets with their currencies plunging to multi-year lows.

Moreover, most of these nations have some structural problems of their own which have added to this turbulence (read: Emerging Market ETFs: Any Bright Spots?).

While the lull is widespread, some nations, popularly known as the ‘fragile five’, have shown extreme vulnerability to the QE taper threat since last year. These nations are – Indonesia, India, Brazil, Turkey, and South Africa.

Interestingly, all five nations have general elections this year which can make or break their growth trail ahead. Let’s dig a little deeper and find out how things are shaping in these nations prior to their key upcoming general elections:

Indonesia

Southeast Asia’s largest economy is due for its parliamentary election in April and presidential election in July. This has sent the Jakarta stock market into rally since the start of the year. The chance of increased campaign spending aided the companies having more domestic exposure especially belonging to food, consumer staples and media businesses, as per Bloomberg.

Historically, the Jakarta stock index added massive returns in the prior two election years – 87% in 2009 and 45% in 2004. Investors have every reason to believe that 2014 will be no exception.

To add to this, nomination of the popular Jakarta governor Joko Widodo as a presidential candidate by the opposition holds promises for the stock market (read: Is it time to buy Indonesia ETFs?).

Notably, Indonesia was buckling under pressure last year with widening current account deficit and the tumbling currency. iShares MSCI Indonesia Investable Market Index Fund (EIDO), Market Vectors Indonesia ETF (IDX) and Market Vectors Indonesia Small-Cap ETF (IDXJ) have gained as much as 20%, 17% and 23% so far this year thanks mainly to the election hopes.

India

The general election will be held in India in several phases from 7 April to 12 May, 2014. The news itself has earned the Indian stock market decent return this year. Indian rupee spiked to a seven-month high as foreigners binged on Indian assets on the hearsay that the nation is likely to undergo a government change which will favor its economy. As per Bloomberg, global funds injected as much as $3.5 billion into Indian equity and fixed income markets this month despite taper fears.

However, not just a likely government shuffle but also some upbeat data supported the Indian market recovery this year. Easing inflation, uptick in projected GDP growth rate and a narrowing current account deficit buoyed primarily by government curb on gold imports – have all played a role to lift the Indian markets this year (read: India ETFs Surging: Can This Trend Continue?).

Several analysts are pinning hopes on India ETFs on the potential win of opposition candidate Narendra Modi. Notably, Modi’s policy is being perceived as business-friendly by many investors supporting the stock market. However, there is a different view as well. Some analysts warned of the overvaluation of Indian stocks.

India ETFs, which were one of worst performers last year crushed by slowing growth, mounting inflation and currency woes, gained this year with the biggest ETF WisdomTree India Earnings Fund (EPI) adding 12% in the last one month.

While all funds were up, increased returns were delivered mainly by the small-cap ones. India Small Cap ETF (SCIN), Market Vectors India Small-Cap Index ETF’s (SCIF) and MSCI India Small Cap Index Fund (SMIN) returned more than 12% over the past month. Notably, small-caps normally perform better in a pre-election rally thanks to their domestic focus. 

Brazil

South America’s largest economy, Brazil, is also scheduled for general elections on 5 October, 2014, to elect the President, the National Congress, state governors and state legislature.

Brazil ETFs have been going through a rough patch for over a year. Slowdown in China’s manufacturing sector, a hard hit auto industry, crippling growth outlook and rising inflation are the causes of concern in Brazil.

In fact, a series of rate hikes since last year has not been able to fully contain the inflationary pressure so far. As a result, quite expectedly, Brazil ETFs were down year-to-date (read: Inside the Continued Brazil ETF Slump).

But investors should note that iShares MSCI Brazil Capped ETF (EWZ), EGShares Brazil Infrastructure (BRXX), Market Vectors Brazil Small-Cap ETF (BRF) and iShares MSCI Brazil Small Cap Index Fund (EWZS) gained in the range of 5% to 7.50% over the last seven days (as of March 28, 2013).

Moreover, recent speculation that the current president Dilma Rousseff will not be re-elected spread enthusiasm in the stock market leading to its longest rally since October. Hopes for opposition’s win might have bolstered the Brazilian indices.

However, since Brazil’s election will hit late this year, we expect campaign spending not to pick up right now, though these ETFs start to see a surge in the second half of the year. There is another short-term driver in the cards – World Cup Football running from June 12 to July 13 this year – which will likely support Brazil ETFs in the near term.

Turkey

A presidential election is slated to take place in Turkey this August. Turkey has hit headlines in the recent past for political woes and a clash between the Prime Minister and several Turkish political factions. Initially it has been thought that Turkey might not see a seamless voting process this year, further adding to the uncertainty in the nation, but the nation proved the popular belief wrong.

The pure-play on the Turkish stock market – iShares MSCI Turkey ETF (TUR) – rallied on a considerable victory of the ruling AK Party led by Prime Minister Tayyip Erdogan in local elections. As per Reuters, moderation in political tensions and market-friendly setting helped the Turkish stocks stay steady and the pre-election rally persisted (read: 3 Emerging Market ETFs to Watch for Political Issues in 2014).

Not only election excitement, some potential measures to support its struggling currency, the lira, also lent helping hands to the Turkey ETF. The Turkish central bank recently declared that it may pay interest on the lira portion of the banks’ required reserves.  In the last one month, TUR gained about 10.2%, though much of this enthusiasm may be temporary.

South Africa

The South African parliamentary election will be held on May 7, 2014. This nation is also struggling with a depreciating currency. The ruling party here – African National Congress (:ANC) – is presumed to win yet another five-year term, though by a smaller margin compared to the last win. Probably, that is why South African president presented a cautious budget in late-February despite the impending elections.

Thus, we do not expect election campaign to give enough short-term boost to South Africa, though a little support is warranted. ANC is in power since 1994, but of late was accused of political outrages and a sluggish economy.

The pure-play on South Africa – iShares MSCI South Africa Index Fund (EZA) – which slipped this year initially on broader emerging market weakness gained about 6.0% in the past month.

Bottom Line

In a nutshell, emerging markets will likely be out of favor this year. However, with most markets presently being undervalued, investors might try their luck in the fragile five ETFs this year thanks to the elections --- a short-term driver. And to do this, Indonesia, India and to some extent Brazil would be prudent spaces to tap, though volatility looks to be high in all of the aforementioned markets.

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