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Vanguard MSCI Emerging Markets ETF (VWO), S&P 500 (.INX): Could Emerging Markets Finally Bounce Back?

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The S&P 500 (INDEXSP:.INX) reached new all-time highs last week, with excitement about the prospects of extended periods of Federal Reserve assistance helping to lift the stock market higher. But arguably more remarkable than the big gains for the S&P was the fact that emerging markets finally started to show some signs of life with stock market gains of their own.

Vanguard MSCI Emerging Markets ETF (NYSEMKT:VWO)

The sad state of emerging markets
So far in 2013, emerging-market stocks have been doing terribly. Looking at the most popular exchange-traded funds tracking emerging markets, both iShares MSCI Emerging Markets Indx (ETF) (NYSEARCA:EEM) and Vanguard MSCI Emerging Markets ETF (NYSEMKT:VWO) have suffered losses this year of more than 10%, compared to double-digit percentage advances for U.S. benchmarks.

The challenges that emerging markets have faced are numerous:

  • For more than a decade, investors have gotten used to the idea that the most prosperous emerging-market economies can grow at double-digit percentage rates annually for extended periods of time. Yet as these economies grow, they inevitably face slowing growth, and investors are only now starting to understand that being disappointed about things like Chinese growth falling to the 6% to 8% range is increasingly unrealistic.
  • Many emerging markets, such as Brazil and Russia, are wealthy in natural resources. The plunge in prices for gold and silver as well as more basic commodities like coal and iron ore has really put a damper on economic growth in those countries, as they’ve no longer been able to rely on exporting materials to fast-growing areas like China and India. Brazil has even had to put up with civil unrest and rioting as citizens grow anxious about inflationary pressures and a slowing economy.
  • U.S. investors have taken to emerging markets as a haven for avoiding the dangers and volatility of the U.S. stock market. But now that U.S. stocks are doing so much better than the rest of the world, investors are pulling their money closer to home, exiting emerging-market stocks and exacerbating the magnitude of losses.

Emerging-market woes aren’t limited to stocks, either. Bonds from emerging-market countries have also suffered significant losses, as investors had taken advantage of Fed-provided liquidity to seek higher interest rates abroad. As Treasury rates have climbed, however, their relative creditworthiness has made overseas bonds look less attractive, sending prices sharply lower in many cases.

Is emerging-market risk back on?
Emerging markets certainly showed signs of strength in Thursday’s big market rally, with emerging market ETFs climbing between 4% and 5%.

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