An Idea For When Emerging Markets Rebound

The corruption-induced plunge in Brazilian equities is shaking broader emerging markets exchange-traded funds. As Latin America's largest economy, Brazil is often featured prominently in diversified emerging markets ETFs, meaning even ETFs with exposure to 15 or 20 emerging markets are being punished by slumping Brazilian stocks.

Solid Streak For Emerging Markets

Still, emerging markets have been solid performers and Brazil's political volatility is likely to be contained to that country. Historically, Brazil is one of the most volatile emerging markets, making access to the country via diversified ETFs, not single-country funds, the preferred avenue for many investors. Importantly, the broader emerging markets space is still attractively valued.

Base on price-to-book value, the MSCI Emerging Markets Index trades below its 10-year average price-to-book, something that cannot be said of the S&P 500 and other gauges of developed market stocks.

“Given that EM is the only major region trading below its 10-year average, an investor might be tempted to go 'all-in' on this potential value play, but caution remains warranted,” said State Street Global Advisors (SSgA) in a recent note. “EM’s 10-year average figure is low because the commodity cycle bust, leading to years of negative returns in the region. When gauging value, you never know when an opportunity may be a bit of trap.”

Looking At GMM

The SPDR S&P Emerging Markets ETF GMM is up 13.3 percent year-to-date even with the recent slide by Brazilian stocks. GMM allocates 8.6 percent of its weight to Brazilian stocks, 100 basis points more than what the MSCI Emerging Markets Index devotes to the country. GMM tracks an index from S&P, which does not classify South Korea as an emerging market. South Korea is the second-largest country weight in the MSCI Emerging Markets Index.

GMM is overweight India by about 350 basis points relative to the MSCI Emerging Markets Index. China and Taiwan combine for over 44 percent of the ETF's weight.

“Additionally, if we examine the underlying fundamentals of EM profitability and company leverage, we can see that years of rising leverage and slowing return on equity have reversed themselves,” said SSgA. “While still well off their norms, the direction is encouraging.”

GMM features exposure to over 20 developing economies, but the most of the ETF's most significant country weights are not major commodities exporters, meaning they can endure or even benefit from lower commodities prices.

“Some EM nations rely heavily on commodities, and the market may be applying a discount to the region based on past commodity influence, as mentioned above,” said SSgA.