Tuesday, September 4, 2007

The Emerging Markets Engine

As I write this, the EEM is about 6% off of its 52 week high, but even this number dramatically understates the staying power of this emerging markets ETF.

A better way to think about the strength of the EEM is to look at its performance relative to that of the EFA, a capitalization-weighted ETF that necessarily tilts strongly in the direction of the most developed countries in Europe, Australasia and the Far East, as the fund’s holdings confirm.

Looking at a ratio chart of the EEM to the EFA, you can see that over the course of the past 4 ½ years, returns in emerging markets have consistently outstripped those of the EFA, save for two brief periods in the summer of 2004 and the summer of 2006. What I find particularly interesting is that the normally skittish emerging markets barely flinched (note the Williams %R) during the corrections that hit the SPX in February and July of this year. Not only were the dips in emerging markets brief, but the recovery in these markets was much stronger and faster than it was in the SPX or the EFA, as anyone who has watched the Chinese markets and the FXI ETF in particular can attest to.

Other ratios of speculative activity, such as the capitalization ratios of the RUT:OEX or RUT:SPX, reflect some of the battle scars of the last few months. Speculative activity in emerging markets, however, continues to show healthy investment in that sector. Whether speculation in emerging markets is in fact too healthy may become an issue in the coming year, but for now I am content to conclude that a powerful emerging markets engine is a positive signal for the global economy.

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