Emerging Markets' Steep Spiral Hits ETFs

August 21, 2015

Slowing economic growth, a stock market crash in China, plunging commodity prices and the threat of a Fed rate hike—these are the concerns that have plagued emerging markets recently and investors are starting to feel the pressure.

Exchange-traded funds tied to emerging markets have been barreling downward all month long, putting most of them deep in the red for the year. The $23 billion iShares MSCI Emerging Markets ETF (EEM | B-99) touched its lowest point in four years today and is now down 13.3 percent year-to-date.

The massive $49 billion Vanguard FTSE Emerging Markets ETF (VWO | B-87) has fared only slightly better, with an 11.6 percent loss.

YTD Returns For EEM, VWO

China Syndrome
For emerging market funds, China is the biggest holding, and thus, the biggest problem. The country makes up almost 19 percent of EEM's portfolio and 21 percent of VWO's portfolio.

By now, the issues facing China are well-known to most investors. Growth in the world's second-largest economy has been slowing significantly. GDP is expected to expand by only 7 percent or less this year, the slowest pace in 25 years.

Some analysts like Chad Morganlander, portfolio manager at Stifel Nicolaus, believe that China's real growth is as low as 4 to 5 percent. That view is echoed by a number of other analysts and economists who question the veracity of China's official growth figures.

While the data may be suspect, one thing that is certain is that the country faces significant challenges in its transition away from an export-orientated economy toward a consumption-driven one.

Falling Currency & Markets
Last week, the People's Bank of China stunned markets after it devalued the yuan to its lowest level since 2012. That fueled speculation that perhaps authorities were growing worried about the sharp slowdown in China's exports, which fell by 8.3 percent from a year ago in July.

Growth issues aside, China is also grappling with the highly publicized crash in its stock market. The Shanghai Stock Exchange Composite Index lost nearly a third of its value since June, which prompted the government to take drastic measures to stem its decline.

Though none of the broad-based emerging market ETFs holds mainland China A-shares yet (that's scheduled to change later this year), they've certainly been impacted by the simultaneous drop in other China share classes, such as those that trade on Hong Kong.

If China's stock market continues to crash, emerging market ETFs are likely to continue to struggle.

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