3 Reasons to Reconsider Emerging Market Stock ETFs

Yesterday, June 2, 2011, 14-year old Sukanya Roy rocked the first place trophy at the 2011 Scripps National Spelling Bee. For some reason, I thought of my 14-year old daughter, and wondered whether she could spell “perescii.”

Then my mind shifted to something else entirely. Specifically, I wondered how many Americans could spell the word, “ethnocentrism.“ It is essentially spelled like it sounds. What’s more, it aptly describes the investing tendencies of many Americans.

In essence, scores of U.S. investors regard the S&P 500 as the star at the center of the financial universe, while foreign stock benchmarks merely exist like planets in orbit. (I’m as guilty as the next ... no judgments here. And I lived in Southeast Asia for roughly four years.)

Don’t believe it? You may wish to inspect your 401k or brokerage account(s). Although half of the world’s stock market capitalization comes from outside the U.S., many of us only have 0%-20% of foreign stock exposure. (Note: It’s not much different when it comes to advisers. My peers typically recommend 20% or less overseas.)

In truth, we feel more comfortable when we invest in what we know. After all, most of us couldn’t spell Malaysia, let alone identify the country on a map.

That said, emerging market economies are growing 2-3x faster than the U.S. or Europe. It follows that if you want to be more successful in the months and years ahead, you’ll need to lose the ethnocentrism.

Granted, through the prism of 1/1/11-6/3/11, you may have been better off in U.S. ETFs alone. However, emerging market ETFs have been recovering from 2011 lows, whereas U.S. ETFs could be heading in the opposite direction.

Here are three reasons to consider emerging market ETFs right now:

1. Central Banks in Developing Countries Will Soon Shift From Tightening to Neutral: Many an ethnocentric individual has talked about how Japan’s recession adversely impacted U.S. GDP in the first half of 2011. That may be a convenient way of looking at a half-empty American cup.

However, emerging economies like China and India have been deliberately curbing their white hot economies for the past nine months. Japan’s recession may have helped the cause, making it possible for central banks in emerging Asia to stop the rate hikes sooner. In other words, you may not need to fret the end of QE2 in the U.S. when you’ve got the end of tight monetary policy in emerging Asia. (Consider SPDR S&P China GXC.)

2. Japan’s Need to Recover: In the near-term, the world’s third largest economy will certainly rebuild. Countries like Malaysia (EWM) and South Korea (EWY) benefit tremendously from that need, as they are top-of-the-line providers of materials and services to Japan. In fact, since the earthquake/tsunami date of 3/11/11, EWM and EWY are up 5.3% and 11.5% respectively. The S&P 500 SPDR Trust (SPY)? 0%.

3. Changing of the Guard in Relative Strength Percentile Rank: On a chart or in a table, one can examine the year-to-date performance spread between Vanguard Emerging Markets (VWO) and the S&P 500 SPDR Trust (SPY). At one point in March, the difference was as wide as 700 basis points. Today, it is down to roughly 300 basis points.

More importantly, VWO is moving in the right direction over the last three months. Across the entire ETF universe, SPY has traveled from a relative strength percentile rank of 62 to 47; conversely, VWO has journeyed from 40 to 60.

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.