Surging EM Stocks Could Tank Again

With emerging markets stocks standing tall on the world scene lately, blowing past the S&P 500, the current slide in the prices for oil and other commodities is not a good portent. Should investors worry about that?

The last time petroleum and commodities dropped—oil hit $26 per barrel in early 2016, down from $110 in mid-2014—emerging market shares tumbled almost a third. The reason: Many of these countries depend on commodities, and those that don't, got swept up in the stock selling frenzy. As commodities recovered, so did the economies and the stock markets in emerging nations, cbsnews reported.

Lately, though, there appears to be an eerie repetition: Crude oil, as represented by the United States Oil Fund, is down 25% this year. Commodities (including oil), as seen via the PowerShares DB Commodity Tracking exchange-traded fund, are off 8% in 2017.

But thus far, that hasn't resulted in an emerging markets fall. Quite the contrary: The Vanguard FTSE Emerging Markets ETF, which tracks a standard commodity gauge, has climbed 14% thus far this year, besting the benchmark S&P 500's showing, now just shy of a 9% gain.

This seeming paradox has caused some investment analysts to worry. Howard Gold, who runs Golden Egg Investing, wrote earlier this year that their prospects were shaky. For one thing, China, the premier emerging nation, has seen its economic growth slow. For another, Gold noted, Morningstar researchers have estimated a 10% annual earnings growth rate for companies in emerging markets over the next five years, versus 9% for members of the S&P 500. "That's not a big premium for markets that are roughly 50% more volatile," he pointed out.

Those are valid points. Yet maybe emerging markets' out-performance is not an accident waiting to happen—where investors wake up and cry: What were we thinking? And it's 2014-2016 all over again.

Blanket Reaction

Some market analysts believe a difference exists between now and the bad old days. Last time, a trio of perceived dangers scared investors, according to Nafez Zouk, lead emerging markets economist with Oxford Economics: China's economic growth was slowing, the Federal Reserve was poised to raise interest rates and, of course, oil and commodities were plummeting due to over-production.

"So we saw a blanket reaction" affecting all emerging nations, he said. Nevertheless, the nightmare triple threat dissipated. China apparently has, through fiat, stabilized its economy by, among other things, stanching an outflow of capital to the West in search of better returns. The Fed's rate-raising regimen is slow and deliberate—and well telegraphed. And production cutbacks led to higher oil prices, hence better prices for commodities.

Indeed, some Wall Street types are gung-ho on emerging markets, which include places like India, Indonesia, Brazil, Mexico, Poland and Russia, in addition to China. These nations' gross domestic products, for the most part, are growing faster because they are starting from a lower base. Plus, their stocks are mostly cheaper.

Other Factors

Global synchronized expansions. For once, the major regions of the world are enjoying improving economies. The European Union has come through its harrowing ordeal over high-debt members like Greece, for instance. Even perennial weakling Japan has scored its longest winning streak in more than a decade, with five straight quarters of GDP increases.

Fed's action. The Fed's increases are slow and measured, and it plans to decrease its enormous $4.5 trillion in bond holdings in modest batches spread over many years, which should act to buoy long-term bond yields. Meanwhile, the Bank of Japan and the European Central Bank are doing what the Fed used to, pumping out money to spur growth. "A lot of it is flowing into EM assets" in search of good returns, said Charles Biderman, founder of TrimTabs Asset Management, just acquired by Informa Financial Intelligence.

The dollar is falling. As many commodities are tied to US currency, this helps commodity-producing nations. The two are inversely correlated. In other words, when the dollar's value dips, it costs more dollars to purchase commodities.