As we approach the halfway mark of 2018, my pick in InvestorPlace’s Best ETFs for 2018 isn’t off to the best of starts. At time of writing, the iShares Emerging Markets Dividend ETF (NYSEARCA:DVYE) is down about 6%.
We still have six months left to go in 2018, and I consider DVYE to still be in the race. When emerging market stocks move, they really move. Furthermore, the leader at the halfway mark — Todd Shriber’s ALPS Medical Breakthroughs ETF (NYSEARCA:SBIO) — is up only 16%.
In a volatile year like 2018, that is by no means a safe lead.
Furthermore, apart from Kent Thune’s Energy Select SPDR ETF (NYSEARCA:XLE), James Brumley’s Powershares Water Resource Portfolio (NYSEARCA:PHO) and Jeff Reeve’s Vanguard FTSE All-World ex-US Small-Cap ETF (NYSEARCA:VSS), literally every other contestant is long technology or biotechnology. Even John Jagerson and Wade Hansen’s choice of the Market Vectors Rare Earth ETF (NYSEARCA:REMX) is indirectly a tech play, as rare earths are used in batteries and other tech components.
The long-tech trade is extremely long in the tooth at this stage of the bull market. I believe the next stage of the bull will favor value sectors and overseas stocks that have largely missed out on the gains of recent years.
So, come December, don’t be surprised if DVYE is duking it out with XLE and VSS for first place.
In the meantime, let’s go over why I believe emerging markets make sense … and why the sector has struggled of late.
The Case for DVYE
I’ll start with the second question. Emerging markets took a hit in February, along with the rest of the stock market, due mostly to the market being overbought and to fears over rising bond yields. But while U.S. stocks have since mostly recovered, most non-U.S. stocks have not.
Part of this is due to dollar strength. The dollar has been on fire since early April, and a stronger dollar means that stocks dominated in foreign currencies have an extra currency hurdle to jump. Political instability, particularly in Turkey and Venezuela, hasn’t helped either.
But the far larger specter looming over non-U.S. stocks is the escalating trade war. Thus far, it has been mostly a war of words, but the fear is that it gets out of hand. The U.S. would “win” a trade war (if you can really define it as “winning”) in the sense that most emerging markets depend more heavily on exports and are thus more exposed. This fear is taking its toll on emerging market stock prices.
Perhaps I’m an optimist, but I believe this trade war will come to a head soon. Perhaps I’m overly optimistic, but I suspect this is some sort of bargaining tool.
But even if I’m wrong about that, my biggest reason for staying long and strong emerging markets is valuation. According to data compiled by Star Capital, the United States is one of the most expensive markets in the world, with a cyclically adjusted price/earnings (“CAPE”) ratio of over 30.
Emerging markets as a group trade at a CAPE of just 16.8. And the three countries that make up largest allocation to DVYE — Taiwan, Russia and China — sport CAPEs of 21.4, 6.4 and 18.6, respectively.
Furthermore, the recent declines have to be taken in context. Like virtually all emerging market stocks, DVYE endured several years of bear market misery that only ended in early 2016. From that bottom until the top earlier this year, DVYE popped by about 80%. For now, I’m viewing the correction in 2018 as being normal profit taking that is part of a much larger multi-year move higher.
Time will tell, of course. And emerging market investors have certainly had their fair share of disappointment over the past decade. But if you believe, as I do, that U.S. stocks are due to cede leadership to their foreign peers for a at least the next couple of years, then having DVYE in your portfolio makes sense.
As of this writing, Charles Sizemore was long DVYE.
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