Schaeffer's Trading Floor Blog

Is It Time to Jump Back Into Emerging Markets?

Checking in on the EEM following its late-January sell-off

by 2/13/2014 7:26 AM
Stocks quoted in this article:

Yogi Berra once said something to the effect of, "that restaurant is so crowded, no one goes there anymore." If someone asked him his opinion of emerging markets, he might have a similar opinion about a crowded trade that no one has on. But, hey, maybe it's time to jump back in. This from The Wall Street Journal's Money Beat:

As concerns about the U.S. Federal Reserve trimming its monthly stimulus measures and an economic slowdown in China mount, riskier assets have floundered. MSCI's emerging-market shares index, priced in dollars, has dropped 6.7% since the start of the year. Investors, seeking to curb losses, have been fleeing in droves.

Yet the panic may be overdone, some money managers say.

The evidence: the discount on emerging-market stocks relative to their developed-market cohorts on a price-to-earnings basis was 33% at the end of January, the widest it has been since May 2005, monthly data from MSCI show.

The iShares MSCI Emerging Markets Index (ETF) (NYSEARCA:EEM) is the easiest way to proxy the sector, and much like our own markets, the options sentiment got a bit extreme before its recent turn for the better.

Here's the implied volatility (in blue) versus the shares over the past year:

EEM Implied Volatility Versus Price Since February 2013

We didn't quite get back to the levels of July, but volatility did hit six-month highs. And it was heavily tilted towards puts.

EEM Put/Call Open Interest Ratio Since February 2013

I suppose it's all a non-confirmation. Neither the put/call open interest ratio nor the implied vol got to the July levels, even though EEM itself hit pretty much the same lows, but I wouldn't read all that much into that. There's a bevy of moving parts that go into options pricing. The move in EEM itself last June and July was more extreme than this latest move, and the realized volatility backdrop was higher. I can't honestly remember everyone obsessing over emerging markets then -- that drop was more about fear of the taper. Emerging stocks were along for the ride back in June, whereas this go-around, worries that the taper (now a reality) would hurt their economies hit them first and hardest, and then rippled here.

At least that's the perception. I hate tying Cause X to Effect Y in the markets. That's because everyone takes relationships like those as givens, and they never work the same way on the next go-around.

That's all a long-winded way of saying the large -- but not extreme -- volatility reaction in EEM this time seems basically in line. The dynamics were just different. I'm no fundamentalist, but that's certainly an interesting valuation case up above. I imagine this perception of taper damage will keep the EEM world cheap on a relative basis. So, if you feel that's more than priced in, bullish plays in EEM could have some appeal.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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