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Leveraging Up The Emerging Markets ETF Trade

ETF Professor

The MSCI Emerging Markets Index, to which about $1.5 trillion in active and passive assets are benchmarked, is up 18.4 percent year-to-date, putting the widely followed emerging markets gauge on pace for its best annual performance since 2010.

That also means risk-tolerant traders have enjoyed a solid run by the Direxion Daily Emerging Markets Bull 3X Shares (Direxion Shares Exchange Traded Fund Trust (NYSE: EDC)). EDC attempts to deliver three times the daily returns of the MSCI Emerging Markets Index. Leveraged ETFs are best used as short-term trading instruments. For example, EDC is not up three times as much as its underlying index year-to-date, but over the past month, the leveraged ETF is up slightly more than triple the emerging markets benchmark.

The Power Of A Weaker U.S. Dollar

The weaker U.S. dollar has been a primary catalyst in driving developing world equities higher this year and with it appearing as though the Federal Reserve will only raise interest rates once this year, if that, the weaker dollar could persist.

Related Link: These Aren't Middling Returns With This Mid-Cap ETF

“The dollar continues to show no signs of strengthening. Quarter-to-date (8/17) the dollar has weakened -1.41 percent. Current Personal Consumption Expenditures (PCE) data has been below trailing FED expected levels. PCE tracks the overall price changes for goods and services purchased by consumers. As of the last report, PCE is at 1.6 percent below the expected 2.0 percent level,” said Direxion in a recent note.

As investors have learned in recent years, even the mere speculation of hawkish action by the Fed can be a drag on emerging markets stocks, and the stronger dollar weighs on commodities, pressuring stocks in commodities-driven developing economies.

What It Means For Emerging Markets

The weaker the dollar remains, the more appealing emerging assets are. Emerging markets governments and some corporations binge borrowed in dollars during the various versions of the Fed's quantitative easing programs. It looked smart as the dollar weakened against a plethora of developed and emerging currencies, but those emerging markets borrowers were caught off guard when the dollar started soaring several years ago.

“Emerging markets political tensions have subsided. The market seems to have recovered from the unexpected/unsuccessful coup in Turkey. And in Brazil, the political tension surrounding the impeachment of President Rousseff coupled with the excitement of the Olympic Games continues to shed positive light on the region,” added Direxion.

EDC's bearish counterpart is the Direxion Daily Emerging Markets Bear 3X Shares (Direxion Shares Exchange Traded Fund Trust (NYSE: EDZ)).

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