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EM Waiting for the Deal to Go Down

October 04, 2019

Thanks to the overperformance of Japan and the underperformance of China, developed markets have bested emerging markets over the last two months. And given the strength of the US Dollar, investors are increasingly taking a polarizing position on their future direction.

Our model continues to paint a mixed picture on positioning for developed markets relative to emerging markets as relative valuations are extremely attractive for emerging markets, but short- to intermediate-term momentum points to favoring developed markets. From a fundamental perspective, the potential for progress on a trade deal between US and China would tilt us in favor of EM.

Emerging Markets and the US Dollar

  • Thanks to emerging markets’ outperformance in November, December and January, developed markets carry only a 0.39% advantage over the last 12 months. However, DM has trounced EM by 6.18% over the last 6 months, as the trade tensions between China and the US have continued to make little material progress.
  • Another driver of performance has been the US Dollar as the correlation between the ratio of developed and emerging markets performance has been 0.70 this year, which is consistent to its long-term average highlighting that this year’s EM weakness amid dollar strength should not be much of a surprise.

As the Dollar has Gone this Year, so have Emerging Markets

Source: Bloomberg Finance, L.P., MSCI, as of September 30, 2019. Data displays the ratio of the total returns of developed markets defined as the MSCI EAFE IMI and emerging markets defined as the MSCI Emerging Markets IMI over the last year. Past performance is not indicative of future results. One cannot invest directly in an index.

Slower Outflows in Emerging Markets

  • Over the last 2 years, relative flows between DM- and EM-focused ETFs have witnessed sizable changes. Flows in favor of DM ETFs peaked in July 2018, which was a period that coincided with investors redeeming close to $10 billion from EM ETFs. Flows in favor of emerging market funds peaked in April 2019 when investors were still adding to EM ETFs and pulling money from DM ETFs.
  • Since that time, emerging markets began a pattern of outflows that only recently subsided as EM took in $356 million in September helping to modestly cut into the sizable redemptions.

Emerging Market ETF Outflows have Stabilized

Source: Bloomberg Finance, L.P., as of September 30, 2019. Data represents the rolling 3-month net flows of U.S.-listed Developed Markets ETFs and Emerging Markets ETFs specifically targeting exposure to broad developed market and emerging market equities respectively.

What’s Next?

Investors have to play the cards they are dealt when it comes to navigating any market environment, but the ongoing trade tensions make that harder to do, thanks to its often changing rules as the Global Economic Policy Uncertainty Index, calculated by Professors Scott Baker, Nick Bloom, and Steven David, hit an all-time high last month.

  • For example, while the Trump administration partially walked back news reports that the US was looking to impose limits for Chinese companies ranging from listing on US stock exchanges and limiting US pension fund exposure to Chinese firms, considerable uncertainty exists for investors to make informed decisions about the outlook for DM relative to EM.
  • Should China and the US be able to make a deal, or steps towards one, in the near-term as talks are scheduled to start on October 10th, emerging markets would likely see a massive bounce as the overhang of current and future tariffs declines, which could help to reaccelerate depressed global trade that has weighed on manufacturing negatively.

Developed Markets have Outperformed Emerging Markets for a Second Month

Source: MSCI, as of September 30, 2019. Data displays the relative total returns of developed markets defined by the MSCI EAFE IMI and emerging markets defined by the MSCI Emerging Markets IMI. Past performance is not indicative of future results. One cannot invest directly in an index.

Implementation Ideas

  • For investors who wish to overweight developed markets and underweight emerging markets, the Direxion MSCI Developed Over Emerging Markets ETF [RWDE], delivers increased exposure to developed markets and decreased exposure to emerging markets driven by a capital efficient 150/50 structure.
  • Those investors interested in overweighting emerging market equities and overweighting developed markets, the Direxion MSCI Emerging Over Developed Markets ETF [RWED], which has 150% weight to the MSCI Emerging Markets Investable Market Index and a negative 50% weight to the MSCI EAFE Investable Market Index is a compelling solution.


  • 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.

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