The Spotlight Blog

Relative Weight Spotlight – Come Together: Emerging vs. Developed Markets

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What We’ve Seen

  • While investors should always take survey data with a grain of salt thanks to self-reporting, the most recent BofAML Global Fund Manager Survey offers detailed insights into the views of investors concerning the state of Developed and Emerging Markets. Investors reported being overweight Emerging Markets and underweight the UK, Eurozone and Japan with the Eurozone and Japan being the two areas with the greatest negative changes month-over-month. Current allocations to the UK, Eurozone and Japan are 1.1, 0.9 and 0.1 standard deviations below their long-term allocation averages, respectively. Interestingly, short European equities replaced long Emerging Markets as the “most crowded trade” highlighting the view that these respective trades may have gone too far too fast.
  • Investors in the survey must be expecting the last 6 months of performance will continue as emerging markets have outperformed developed markets by a whopping 7.02%. Of the top 10 performers at the country level over the last 6 months, 9 are classified as Emerging Markets, with Brazil leading the pack with a 39.23% return. However, the last 1 and 3 months have brought a moderation to this trend with Emerging lagging Developed Markets by 0.03% and 0.38%, respectively.

 
Emerging Markets have Dominated Developed Markets over the last 6 Months

Country Classification Total Return (%)
Brazil Emerging 39.23
Turkey Emerging 24.34
Hungary Emerging 19.87
Philippines Emerging 14.11
Indonesia Emerging 13.68
Russia Emerging 10.49
Egypt Emerging 9.77
Hong Kong Developed 9.56
Colombia Emerging 9.39
Peru Emerging 8.27

Source: MSCI, as of March 19, 2019. Data represents the 10 best performing countries in the MSCI ACWI IMI. Past performance is not indicative of future results. One cannot invest directly in an index.

Money in Motion

  • Rolling 1-month flows highlight a recent convergence between Developed and Emerging Market ETFs as Developed took in $745 million over the last month and Emerging saw $857 million of inflows. In fact, flows between the two have been neck and neck over the last 6 days (ending March 19, 2019).
  • This comes on the back of flows into Emerging Markets ETFs dominating Developed Markets ETFs over the last 6 months. Flow differences peaked in early February at $11.76 billion, comprised of $8.36 billion flowing into Emerging Markets, and $3.42 billion of outflows for Developed Markets, highlighting the extent of their convergence.

Emerging and Developed ETF Flows have Converged

Source: Bloomberg Finance, L.P., as of March 19, 2019. Data represents the net flows of U.S.-listed Developed Markets Equity ETFs and Emerging Markets Equity ETFs specifically targeting exposure to developed and emerging markets, respectively.

What’s Next?

  • While sounding like a broken record, the near-term performance of this pair will likely continue to be impacted by the macro environment and any headline risks associated with the outcomes of the U.S.-China trade deal and Brexit. Overall, the slowing trade recently cited by firms including FedEx, BMW and UBS remains paramount due to the reliance that exports play in countries across developed and emerging markets. Tailwinds do exist, however, in the form of a U.S. dollar that has seen slowing strength, and a Federal Reserve that has confirmed the market’s expectations for dovishness.
  • Looking at fundamentals, relative valuations are far from favoring Developed or Emerging Markets when taking a long-term perspective. 2019 earnings expectations point to a more favorable picture for Emerging Markets, especially in the second half of 2019. Of course, a prolonged negotiation of the aforementioned trade deal could weigh on earnings across the board and wipe out any relative benefit considering that Emerging earnings are already expected to be negative in Q2 and Q3.

Earnings Expectations Look to Favor Emerging Market

Source: Bloomberg Finance, L.P., MSCI, as of March 19, 2019. Index earnings estimates are compiled by Bloomberg.

Implementation Ideas

  • With recent performance favoring Emerging relative to Developed, the Direxion MSCI Emerging Over Developed Markets ETF [RWED] offers investors increased exposure to Emerging Markets than a long-only implementation along with risk-controlled short exposure to Developed Markets.
  • Conversely, with the narrowing of ETF flows between Emerging and Developed, the Direxion MSCI Developed Over Emerging Markets ETF [RWDE] offers the opposite view with Developed exposure amplified relative to Emerging. 

 


Definitions

  • MSCI Emerging Markets IMI: The MSCI Emerging Markets Investable Market Index (IMI) captures large, mid and small cap representation across 24 Emerging Markets countries.
  • MSCI EAFE IMI: The MSCI EAFE Investable Market Index (IMI), is an equity index which captures large, mid and small cap representation across Developed Markets countries around the world, excluding the US and Canada.

 

Direxion Relative Weight ETF Risks: Investing involves risk including possible loss of principal. The Funds’ investments in derivatives may pose risks in addition to, and greater than, those associated with directly investing in or shorting securities or other investments. Investing in, and/or having exposure to, emerging markets instruments involves greater risks than more developed markets due to the potential for greater market volatility, lower trading volume, higher levels of inflation, political and economic instability, greater risk of market shutdown and more government limitations on foreign investments in emerging market countries than typically found in more developed markets. There is no guarantee that the returns on the Funds’ long or short positions will produce high, or even positive returns and a Fund could lose money if either or both of the Fund’s long and short positions produce negative returns.  Please see the summary and full prospectuses for a more complete description of these and other risks of the Funds.

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