New Dawn Emerging As Correlations Tighten

October 28, 2008

As losses mount, emerging markets are seeing ETF performances begin to correlate more closely with developed markets.

 

Mainly this year, we've been hearing about the financial troubles in the U.S. and what it means for the economy. But most people seem to have overlooked or minimized the fact that our troubles here have reverberated through global markets to even more severe effect.

At the end of last week, the SPDR S&P 500 ETF (NYSEArca: SPY) was down 39.53% year to date, with the iShares Russell 3000 Index Fund (NYSEArca: IWV) down nearly the same, with returns of -40.50%.

Meanwhile, the iShares MSCI EAFE Index Fund (NYSEArca: EFA) was down an even more dramatic 49.57%. And almost all the emerging markets ETFs saw even worse returns. 

While most investors view emerging markets as a source of diversification, the truth is that such markets have seen their performance begin to correlate more closely with developed markets in recent years as their economies. Emerging markets tend to be the producers of many of the commodities and manufactured goods that developed markets consume, thus when developed markets fall on hard times, more and more, so do emerging markets.

Also, in this particular instance, the credit crisis has spilled over to emerging markets, which are finding loans more expensive as their credit ratings are downgraded. Many such markets have liberalized their economies, following the model of developed markets, and find themselves without currency reserves to fall back upon in emergency.    

The popular iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM) and Vanguard Emerging Markets ETF (NYSEArca: VWO), which both track the MSCI Emerging Markets Index, were both down more than 60% for the same time period. And if there was any doubt that the financial crisis hit these two funds harder than developed markets, a look at the performance during September and the first few weeks of October shows SPY and IWV down a little more than 32% and EFA down about 38%. EEM and VWO were both down about 50%. The SPDR S&P Emerging Markets ETF (NYSEArca: GMM), which tracks the S&P/Citigroup BMI Emerging Markets Index, was down about 57%.

Interestingly, the emerging markets ETFs from PowerShares and WisdomTree both outperformed the other broad emerging markets ETFs. The PowerShares FTSE RAFI Emerging Markets Portfolio (NYSEArca: PXH) and the WisdomTree High-Yield Emerging Markets (NYSEArca: DEM) were down 56.57% and 43.21%, respectively. PXH tracks an index that uses a multi-factored fundamental weighting scheme, while DEM's underlying index is dividend-weighted.

BRIC Distress Acute

It seems the four largest emerging market countries were among the hardest hit, based on the performance of the BRIC ETFs. The Claymore/BNY BRIC ETF (NYSEArca: EEB) and the SPDR S&P BRIC 40 ETF (NYSEArca: BIK) were down 62.45% and 64.99%, respectively, year-to-date. ETFs tracking Brazil and China - the iShares MSCI Brazil Index Fund (NYSEArca: EWZ), the PowerShares Halter USX China Portfolio (NYSEArca: PGJ) and iShares FTSE/Xinhua China 25 Index Fund (NYSEArca: FXI) - were down between 61% and 63%, similar declines to the BRIC ETFs.

It looks like Russia and India are likely the prime culprits in the country group's more significant decline: The Market Vectors Russia ETF (NYSEArca: RSX) and the iPath MSCI India Index ETN (NYSEArca: INP) were down 74.77% and 70.67%, respectively.

Perhaps not surprisingly, it was reported recently that Russia had announced that the four BRIC countries would try to coordinate their efforts to combat the crisis.

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