Sunny Days for EM ETFs if Fed Resists Tapering Temptation

ETF Trends

Emerging markets ETFs vaulted higher last Wednesday after the Federal Reserve surprised financial markets by announcing no changes to $85 billion-a-month in bond purchases. For the bulk of 2013, developing economies and equity markets from Brazil to Indonesia to Turkey had tumbled due to the specter of the loss of easy money from the U.S.

The no tapering announcement not only sparked emerging markets ETFs higher with the iShares MSCI Emerging Markets ETF (EEM) outperforming the SPDR S&P 500 (SPY) for a fourth consecutive week, some global banks got in on the act by issuing bullish comments on emerging markets. [Emerging Markets ETF Leads S&P 500 for a Fourth Week]

“After the highly significant Fed message, global emerging markets (GEM) are settling in in a new regime. That new regime is no longer a bear market, in our view,” said Societe General analysts in a research note obtained by CNBC.

The French bank added that although global emerging markets are still “digesting this massive Fed policy surprise,” it is time to “turn tactically bullish” on developing economies. Even before the no tapering announcement, there was evidence that investors, perhaps spurred by compelling valuations, were starting to nibble at emerging markets ETFs. In the second week of September, EEM raked in $2.5 billion in new assets while the rival Vanguard FTSE Emerging Markets ETF (VWO) brought in $380 million. [Return to me: Cash Flowing Back to Emerging Markets ETFs]

Since the start of this month, single-country funds tracking Brazil, China and South Korea, among others, have seen inflows.

“Our four-factor econometric regression model for Turkey is suggesting 7% upside potential by year end; (ix) Turkey trades at a discount once again versus GEM on sector-adjusted forward earnings and Turkish banks are cheap versus EMEA peers; and (x) there is now 13% potential upside for Turkish stocks to Credit Suisse target prices,” according to a Credit Suisse note posted by Barron’s. 

There are still looming risks to the bullish view of emerging markets. Tapering is an issue that is not dead. Last Friday, St. Louis Fed President James Bullard rankled markets when hesaid the decision not to taper in September was “close” and did not rule out a small reduction in the central bank’s bond purchases in October. The Fed will hold its next monetary policy meeting on Oct. 29-30. Other market observers believe it is unlikely the Fed lets 2014 without some tapering.

On the other hand, the longer tapering is left on the back burner, the more sanguine the environment for ETFs like EEM and VWO. That “better backdrop would likely impact funds flowing back into the emerging markets, with outflows not only decelerating, but reversing,” CNBC reported, citing Soc Gen.

iShares MSCI Emerging Markets ETF

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ETF Trends editorial team contributed to this post. Tom Lydon’s clients own shares of EEM and SPY.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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