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2018's Best ETFs: Watch Emerging Markets

Published 03/29/2018, 11:02 AM
Updated 07/09/2023, 06:31 AM
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If there is a dominant theme in the Best ETFs for 2018 contest, it would seem to be, “Go America!” and specifically, “Go American tech!”

The Market Vectors Semiconductor ETF (NYSE:SMH) is leading the pack, up 7%, and four of the top five places are all held by ETFs specializing in tech or biotech.

But we still have a long way to go in 2018, and tech is starting to show signs of breaking down as we finish out the quarter. I expect my pick – the iShares Emerging Markets Dividend ETF (NYSE:DVYE) to ultimately take the crown.

The U.S. market has been the undisputed winner of the post-2008 bull market. Since March 2009, the SPDR S&P 500 ETF (NYSE:SPY) is up about 240%. The iShares MSCI EAFE ETF (NYSE:EFA) and the iShares MSCI Emerging Markets ETF(NYSE:EEM) – popular proxies for developed foreign markets and emerging markets, respectively – are up 111% and 142% over the same period.

But with that outperformance has come major overvaluation. The U.S. market is the most expensive major market in world based on the cyclically adjusted price/earnings ratio, or “CAPE” (only tiny Denmark and Ireland are more expensive). The U.S. market trades at a CAPE of 31, which is the level it reached in late 1997, in the midst of the dot com bubble.

Meanwhile, emerging markets are downright cheap. As a sector, emerging markets trade at a CAPE of less than 18, and many individual countries are even cheaper. Brazil trades at a CAPE of 14, and Russia 7.

Sometimes cheap stocks are cheap for a reason, and emerging markets have certainly had a rough decade. Below-average economic growth in America and Europe sapped export demand, weak energy prices hit commodity-dependent countries and political unrest has been a nagging issue, particularly in Latin America.

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But something funny happened in 2016. While the bad news headlines kept dribbling in, emerging market stocks finally started trending higher. The bad news had finally been priced in, and the last seller had thrown in the towel, so to speak. And as we wrap up the first quarter of 2018, I believe this move is just getting started.

What Could Go Wrong?

As I write this, the market is in sell-off mode, in part due to fears that U.S. sanctions on China could snowball into a bona fide trade war.

Now, I don’t see this happening. President Donald Trump is known to make a lot of noise before ultimately backing off. And there is a limit to how many trade barriers he can erect without getting Congress on board … and that’s not looking particularly likely at the moment.

But, let’s say I’m wrong and this nascent trade war gets out of hand. That would be very bad news for emerging market economies that depend disproportionately on exports to the West.

Well, that’s not the story Mr. Market is telling. While the S&P 500 is down about 2% year to date, the popular iShares Emerging Markets ETF is essentially flat, and the more conservative DVYE is actually up 2%.

This tells me that the stock correction has more to do with technical factors than a true belief in an impending trade war.

DVYE is fairly concentrated in “Greater China,” with 25% of its portfolio invested in Taiwanese stocks and another 11% in Chinese stocks. But another 16% is allocated to Russian stocks, and Brazil and Thailand round out the top five at 9% each. Overall, 15 emerging-market countries are represented.

As a dividend-focused ETF, it’s not surprising that utilities are the largest sector with 15% of the portfolio. But information technology isn’t far behind at 14%, and the ETF has sizable exposure to real estate.

So, DVYE gives you decent diversification both globally and across sectors.

If, like me, you think the U.S. large-cap tech trade has essentially run its course for now, emerging markets are the next likely focus of speculation. And DYVE allows you to get paid a handsome 4.5% in dividends while we wait for this theme to unfold.

As of this writing, Charles Sizemore was long DVYE.

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