A ‘great rotation’ is taking shape, but with an unexpected twist.
For what feels like an eternity, market pundits have been calling for the “great rotation” from bonds to stocks. A rotation is happening, but elsewhere.
The problem with the bonds-to-stocks rotation is that outside of a couple of head-fakes, borrowing rates have remained stubbornly low.
All the while, investors have indeed been reallocating, but in perhaps a different manner than most had anticipated; namely, out of emerging markets equities and into their developed market counterparts.
The two largest emerging markets ETFs—the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) and the iShares MCSI Emerging Markets ETF (NYSEArca: EEM)—have lost more than $11 billion in assets in 2013.
On the other hand, the Vanguard FTSE Developed Markets ETF (NYSEArca: VEA), the PowerShares QQQ Trust (NasdaqGM: QQQ), the SPDR S&P 500 ETF (NYSEArca: SPY) and the iShares MSCI EAFE ETF (NYSEArca: EFA) have collectively seen more than $13 billion in inflows over the first seven-plus months of the year.
This dichotomy speaks to a shift not just in assets, but also in the global economy.
As our own Matt Hougan recently pointed out, the total market segment of the emerging markets space has been extremely weak in 2013. The iShares Core MSCI Emerging Markets ETF (NYSEArca: IEMG) that tracks perhaps the most comprehensive emerging markets index—the MSCI Emerging Markets IMI—has fallen more than 9 percent this year.
A combination of monetary tightening measures in China; civil unrest in Turkey and Brazil; and economic restructuring has made the developing world less appealing relative to the developed world—regardless of the fiscal challenges facing the latter.
Call it the cleanest-dirty-shirt dynamic.
While it may seem easy to pick apart the logic of transitioning assets to developed equities markets, the fact is that U.S. equities and the iShares MSCI EAFE ETF (NYSEArca: EFA) are both up this year, and even the iShares MSCI EMU ETF (NYSEArca: EZU) is quietly up 3 percent year-to-date, while emerging markets sit well in the red.
Meanwhile, the IMF recently cut its growth forecast for emerging markets—along with the rest of the world—citing, among other things, a negative outlook for exports.
To that end, the inability of emerging markets to grow and maintain exports in a world where nearly all central banks are openly debasing their currencies poses perhaps the biggest obstacle and opportunity for these markets.
On the one hand, so much of the developing world’s returns over the past decade have been fueled by resource and manufacturing exports.