January 4, 2014

Emerging Markets on a Bearish Path

The BRICs declined more than 5% on average in 2013, with some indicators looking less than rosy for 2014-2015

Rio de Janeiro, Brazil Rio de Janeiro, Brazil

Emerging markets were supposed to be the panacea to lackluster global economic growth. Instead, they’ve delivered nothing but subpar performance over the past several years.

While stocks from developed countries have gained 15.17% over the past three years, emerging market stocks by comparison have fallen 16.06%.

Is a rebound ahead?

Fearsome Four

Among the largest global emerging economies are the BRICs--an acronym for Brazil, Russia, India, and China. Together, they account for more than 40% of the world’s population.

Some economists estimate BRICs will overtake G-7 economies in GDP by 2027. Another report, released by Goldman Sachs in 2010, estimated the four BRICs may account for 41% of the world’s market capitalization by 2030.

Despite a promising future, BRICs have lost their luster.    

In 2013, the iShares MSCI BRIC ETF (BKF) declined 5.30%, putting the BRICs' performance slightly behind that of the broader Vanguard FTSE Emerging Markets ETF (VWO), which weakened 4.92% last year. China was the only BRIC country to eke out a 2013 gain.

Asia’s Juggernaut

Speaking of China, the country is in the midst of another liquidity crisis, which continues to be downplayed by its officials. A combination of rising interest rates and of the PBOC’s money tightening caused a year-end cash shortage. The interbank rate (the rate banks charge each other for short-term loans) spiked causing investors to worry which banks will default on their loans.

The velocity of China’s growth is slowing, too. China’s non-manufacturing purchasing managers’ index declined to 54.6 last month, its worst showing since August 2013.This is a whole lot less than economists were projecting.

The real action in China has been in the stock market where Shanghai equities have been trading with approximately the same volatility as penny stocks.

In our Dec. 4 ETF alert to subscribers, we were ready for this and we wrote: “While we respect the rally Chinese and all emerging market stocks have enjoyed, we’re nonetheless suspicious about the sustainability of the run. Aside from huge systematic risks, the Federal Reserve’s eventual scale back of QE is a threat to rising asset prices. We’re buying ProShares UltraShort China ETF (FXP) at around $14.65.”

Since then, FXP, which aims for double daily opposite performance to Chinese stocks, has jumped around 10%. The Direxion Daily FTSE China Bear 3x Shares (YANG) have surged 20.54%. How much lower can Chinese stocks fall?

If we analyze recent declines in the iShares China Large Cap ETF (FXI) from previous peaks, we get a clue. FXI, which is linked to the same index as FXP, declined 17.25% from May 7 to Jun. 25, 2013 and 16.17% from Feb. 1 to Apr. 17, 2013.

The current decline from FXI’s Dec. 6 peak has already resulted in a 7.5% loss. The two most recent drops suggest at least another 10% in potential downside. We remain long FXP and have since raised our stop loss to $15.

Looking Ahead

A coincidental indicator called the Skyscraper Index could foreshadow even deeper economic problems in China and the rest of emerging markets.

The concept was invigorated in 1999 by Andrew Lawrence, research director at Dresdner Kleinwort Wasserstein, who argued that skyscraper projects are an indicator of economic crisis, not boom.

Lawrence’s research cited the erection of the World Trade Center and Sears Tower during the 1973-74 bear market along with the opening of the Petronas Twin Towers in the wake of the 1997 Asian Financial Crisis.

What about today? The Shanghai Tower is scheduled for completion in 2015 and will become China’s tallest building, topping 2,074 feet (632-meters). 

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The ETF Advisor Pro uses a combination of market sentiment, fundamental/technical analysis, history, and common sense to be on the right side of the market. In 2013, 70% of our time stamped ETF picks have turned a profit; follow us on Twitter @ ETFguide

 

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