How you can Profit from the Collapse in Emerging Markets

After years of easy money and a failure to secure a well-executed exit plan, it looks as though the emerging markets are getting a taste of the Federal Reserve’s economic tapering. Over the last five years, the emerging markets have benefited from low interest rates and listless growth in developed countries. 

But, with the U.S., Japan, and Europe—the three biggest economies globally—all expanding for the first time in four years, the tables are turning and the sheen is beginning to wear on the emerging markets. 

In an effort to help kick start the U.S. economy after the financial crisis in 2008, the Federal Reserve enacted it’s overly generous bond buying program (quantitative easing). All told, the Federal Reserve dumped more than $3.0 trillion (and counting) into the markets and has kept interest rates artificially low. 

The ultra-low interest rates might have been great for home buyers, but income-starved investors had to look elsewhere to pad their retirement portfolio. Many retail and institutional investors went to the emerging markets, where the interest rates were higher and there was a real opportunity for growth. 

In December, the Federal Reserve said it was going to begin tapering its $85.0-billion-per-month quantitative easing strategy to $75.0 billion a month in January and $65.0 billion a month in February. While the amount is negligible, it signals the eventual end of artificially low interest rates. The cheap money that propped up asset prices in emerging markets, like India, China, and Indonesia, is beginning to crumble. 

The Argentinean peso, Indian rupee, South African rand, and Turkish lira have all hit the skids. And like investors running for the exits with reckless abandon, this has also taken down the currencies of less troubled countries, like Mexico and South Korea. 

To add salt to the emerging market’s wound, China released weak manufacturing numbers last week, exacerbating fears on Wall Street. China’s preliminary Purchasing Managers’ Index (PMI) numbers for January show that economic growth momentum is slowing rapidly. The preliminary manufacturing numbers slipped to 49.6 in January from 50.5 in December. January’s PMI numbers show the lowest level in six months. (Remember, a reading below 50 indicates contraction, while a reading above 50 shows growth.) 

Economic turmoil in the emerging markets is rippling through the North American markets. The S&P 500 is down more than three percent so far this year, the Dow Jones Industrial Average has erased almost four percent of its value, the NYSE is down almost three percent, and the NASDAQ has declined more than 1.5%. 

Though those numbers shouldn’t be a total surprise; the Chicago Board Options Exchange (CBOE) Volatility Index (VIX), also known as the “Fear Index,” is up more than 12% since the beginning of the year, more than 27% over the last week, and more than 17% over the last few days. 

Investors have lost faith in the emerging markets and that fear is coming home to roost. It has set North American markets up for a solid correction. If that does occur, investors might want to consider running against the herds heading towards the exits. 

In spite of the sell-off in the emerging markets, investors shouldn’t shun all emerging market exchange-traded funds (ETFs). Just as the mass sell-off in 2008 sent a lot of great stocks spiraling out of control, fears about the emerging markets will unfairly punish a number of solid emerging market economies. 

The iShares MSCI Emerging Markets (NYSEArca/EEM) ETF has interests in Brazil, China, and India, but also fundamentally solid economies like Mexico, Taiwan, and South Korea. Vanguard FTSE Emerging Markets ETF (NYSEArca/VWO) is another emerging market ETF worth investigating. 

Investors might see the emerging markets as one single asset class. But they aren’t. And the solid emerging market economies will rebound. The big question is, how long will it take?

~ by John Paul Whitefoot, BA 

This article was originally published at Daily Gains Letter