Will EM ETF Rally Hit the Brake to Start Q3?

Emerging market (EM) ETFs have had a great run in the last one year (as of June 19, 2017) with iShares MSCI Emerging Markets EEM returning over 24%. This year, the segment is doing well on improving global economic fundamentals and accommodative developed market central banks that are still keeping interest rates low. The fund is up 18.9% so far this year, almost twice the returns offered by SPDR S&P 500 ETF SPY.

Some of the key reasons for this outperformance were a subdued greenback, commodity market strength and policy easing in several EM economies that facilitated growth. In fact, though EMs used to underperform in a rising rate environment, the bloc has become a lot more insulated lately.

Several analysts also believe that developed market reflation has probably reinforced the China-EM pickup as part of the growth momentum in the developed world has trickled down to emerging markets in the form of trade and investments.

Are Tables Turning?

Most recently, the World Bank indicated that "a slowdown in investment into developing economies has put the brakes on productivity growth in emerging economies." Still, the World Bank forecast EM growth of 4.1% in 2017, up from "a post-2008-crisis low of 3.5% in 2016", which appears decent (read: Can Emerging Market ETFs Retain Their Mojo in 2017?).

As per the article published on Financial Times, World Bank's economists noted that "even if the expected modest rebound in investment across [emerging and developing economies] materialises, slowing capital accumulation in recent years may already have reduced potential growth."

If we consider the big emerging economies, we will see China struggling with elevated debt levels. Brazil has been striving with political woes. Russia may see a slowdown with oil prices seeing no material uptick after the output cut deal. Mexico has been facing tensed trade relation with the Trump administration while Turkey has been battling with domestic political issues (read: Should You Buy Brazil ETFs After Brutal Sell-Off?).

Most Broad EM ETFs Are Hold Rated

Notably, given these concerns and rising valuations, most broad EM ETFs have a Zacks ETF Rank #3 (Hold). In fact, Russia ETFs like VanEck Vectors Russia Small-Cap ETF RSXJ and VanEck Vectors Russia ETF RSX have a Zacks ETF Rank #4 (Sell).

Against this backdrop, investors may want to playiShares Edge MSCI Minimum Volatility Emerging Markets ETF EEMV. The fund has a net expense ratio of 0.25% and gives exposure to emerging market stocks with lesser risks. The fund has a Zacks ETF Rank #2 (Buy).

Investors can also take a look at EM funds that have a low P/E ratio and still boast a compelling valuation. These funds have a lower P/E ratio than SPY which has a P/E of 17.79 times.

After all, EM economies are much more insulated from Fed tightening shocks this time than they were in previous periods. Volatility in the EM space has ebbed lately, currency issues have somewhat stabilized, and fundamentals have strengthened.

ETFs in Focus

WisdomTree Emerging Markets Quality Dividend Growth Fund DGRO – P/E 15.67x

Schwab Emerging Markets Equity ETF SCHE – P/E 13.57x

iShares Currency Hedged MSCI EM Minimum Volatility ETF HEMV – P/E 15.75x

PowerShares S&P Emerging Markets Low Volatility Portfolio ETF EELV – P/E 13.99x

FlexShares Currency Hedged Morningstar EM Factor Tilt Index Fund TLEH – P/E 16.57x

Columbia Emerging Markets Core ETF EMCR – P/E 16.96x

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