Emerging Markets Outlook Bleak

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Gary Stringer, president and chief investment officer of Memphis, Tennessee-based Stringer Asset Management.

We generally classify emerging market equities and bonds among the asset classes that we consider tactical holdings, as opposed to long-term strategic allocations.

We think there are times to own and times not to own tactical assets, such as high yield bonds, commodities and emerging markets. We consider other asset classes that we are comfortable holding for the long term as strategic, such as domestic equities and diversified bonds.

For example, we consider broad equity exposure, as represented by the iShares MSCI ACWI ETF (ACWI), to be strategic.

Meanwhile, we think that narrow, higher risk areas, such as the Vanguard FTSE Emerging Markets ETF (VWO), as tactical. Over the long term, these tactical areas often have greater downside risk (maximum drawdown), higher volatility risk (standard deviation) and lower risk-adjusted returns (Sharpe ratio) than broader strategic investments.

However, there are times when funds like VWO could make great short-term investments, generally being owned for  six to 18 months. For emerging markets, we think these investment opportunities are most prevalent when global economic growth is accelerating and inflation is building.

Many emerging market economies are manufacturing- and/or commodity-production-oriented. Rising leading economic indicators overall and manufacturing PMI new orders would suggest accelerating global economic growth of the kind that can favor emerging market economies and stock markets.

As the following graph illustrates, an acceleration in the pace of global economic growth seems unlikely at this time.

Additionally, higher industrial metals prices can provide support for emerging market equity markets since they reflect greater demand for economically sensitive materials, such as copper and iron ore.

Many emerging market economies are heavily weighted to commodity production, and emerging market equity prices often move in tandem with industrial metals prices, as the following graph shows.

As the graph above illustrates, emerging market equity prices diverged from industrial metals prices beginning in early November.

Without an uptick in economic activity, the weakening of industrial metals prices suggested to us that emerging market equity prices were more likely to weaken rather than industrial metals prices would rally. When prices are vulnerable, any negative shock can send markets tumbling.

Though industrial metals prices may now be oversold, as the coronavirus risk spreads to threaten the pace of economic growth, we think emerging market equity prices could fall further before finally finding a bottom as these risks ultimately recede.

Gary Stringer is president and chief investment officer of Memphis, Tennessee-based Stringer Asset Management, a third-party investment manager and ETF strategist. Contact Stringer Asset Management at 901-800-2956 or at [email protected]. For a complete list of relevant disclosures, please click here.