Emerging Markets EEM ETFs: Bullish Short-Term Opportunities

Emerging market ahead warning sign chalkboard way

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Emerging markets are always a good place to look for alpha. My investment formative period was from 2004 to 2008 – during this period, niche markets outperformed US equities and developed markets abroad by a wide margin. After peaking relative performance in 2010, iShares Emerging Markets ETFs (NYSE:EEM) Over the past decade, it has been a painful situation for investors to overweight the region. Opportunity costs are real considering the Select SPDR S&P 500 ETF (spy) rose hundreds of percent in that time.

Since November 2010: SPY +332%, EEM +12%

Since November 2010: SPY +332%, EEM +12%

Stockcharts.com

EEM and SPY peaked in late 2010

EEM and SPY peaked in late 2010

Stockcharts.com

The makeup of emerging markets today is very different than it was 15 years ago. The niche market, which accounts for 11% of the global stock market, remains a small piece of the pie, according to JPMorgan Asset Management. In the past, energy, materials and other dollar-sensitive sectors dominated price action in emerging market countries. Resource-rich countries such as Brazil, Russia, Australia, and South Africa made huge gains in the mid-2000s. Fast forward to 2022, and the tech and financial industries are major players — just as commodities are reasserting their importance. Markets can be brutal.

Emerging Markets Not Your Father: 11% of Global Equities

Emerging Markets Not Your Father: 11% of Global Equities

JPMorgan Asset Management

Emerging Market Composition: Finance and Technology Today

Emerging Market Composition: Finance and Technology Today

JPMorgan Asset Management

What has flourished over the past decade or so has been the fixed income sector of emerging markets. Emerging market bonds now account for about 25% of the global fixed income market. This makes the health of emerging market countries even more important in the years to come. As emerging market countries are notorious for their political uncertainty and violent economic cycles, the booms and busts of the credit cycle over the next decade are likely to be more pronounced. The dollar-denominated emerging-market bond market now yields more than 7 percent, helping to boost global fixed-income yields, according to JPMorgan Asset Management.

Emerging market debt now accounts for 25% of the global bond market.Up from 1% in 1989

Emerging market debt now accounts for 25% of the global bond market.Up from 1% in 1989

JPMorgan Asset Management

In terms of valuation, emerging markets are looking very cheap with a forward price-to-earnings ratio of just 11.1, according to data compiled by Ed Yardeni.This compares to 14.7 times global earnings and 17.0 times U.S. earnings

Global stock market valuations: Emerging markets are the cheapest

Global stock market valuations: Emerging markets are the cheapest

Yardeni.com

Still, forward price-to-earnings ratios in emerging markets remain close to their 25-year averages, despite substantial price weakness since their 2007 peak, according to JPMorgan Asset Management.

Emerging market valuations appear cheap, but not by historical standards

Emerging market valuations appear cheap, but not by historical standards

JPMorgan Asset Management

Remember that EPS in emerging markets actually peaked more than a decade ago. Forward estimates for 2022 and 2023 have also declined.

Emerging market earnings per share have remained roughly unchanged since 2007

Emerging market earnings per share have remained roughly unchanged since 2007

Yardeni.com

Technical points

Long term, there is decent support below where EEM is trading now. The problem is that the graph below has no trend. For a seriously bullish case, investors want to see higher lows and higher highs. EEM has been in a prolonged bear market off its 2007 highs. It may be a long time before we get clear evidence of an uptrend. For now, it makes sense to buy the dip in the $36-37 area, but short-term buyers should sell on a strong rally.

For trading: EEM support in the $36-37 range

Support is in the $36-37 range

Stockcharts.com

But don’t choose EEM

According to iShares, the iShares Emerging Markets ETF has an expense ratio as high as 0.68%. Investors with more than 0.5% cheaper than competing ETFs like VWO or SPEM are better served. You can also use a low-cost version of EEM from iShares: IEMG.

EEM’s high fees result in lower returns compared to comparable funds

EEM's high fees result in lower returns compared to comparable funds

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bottom line

For long-term investors, the valuation case looks good, and from this massive base should ultimately pay off handsomely. Considering emerging markets account for 11% of the global market, retirement savers should have that weight in their equity allocation.

Don’t buy EEM for long-term holding, though. Select Vanguard Emerging Markets Stock Index Fund ETF (VWO), SPDR Portfolio Emerging Markets ETF (SPEM), or the iShares Core MSCI Emerging Markets ETF (IEMG).