Should you abandon emerging-market ETFs?

Recent months have been great for funds tracking US sectors but grisly for many in the developing world.

By TheStreet Staff Feb 4, 2011 1:04PM

Image: Earth encircled by money (© Bob Jacobson/Corbis)By Gary Gordon, TheStreet

 

The media remain hell-bent on describing U.S. economic acceleration, Dow 12,000 and marginal labor market improvements. The analysts seem equally giddy, reiterating quotable notables like "Don't fight the Fed!" or "Don't fight the tape!"

 

I agree that there are reasons to be hopeful. We've been privy to robust corporate earnings as well as strong corporate balance sheets, share buybacks and a variety of key acquisitions. Yet I don't agree that investors can disregard the impact of world central bank policy. I certainly don't think we can cast aside the tale of the emerging-market tape.

 

It may seem as though developed-world stocks have decoupled from developing-world equities. The past three months have been dreamy for high-beta U.S. sector ETFs but nightmarish for three-quarters of the BRIC emergers -- Brazil, India and China.

 

With discrepancies as wide as these, should we be surprised by the net outflow of money from emerging-market equities in January? Probably not.

Of course, there's a natural tendency for investors to take profits on their biggest winners in January, and emerging markets were 2010's biggest winners. There's also a reality that many emerging countries are battling inflation through restrictive monetary policy, which in turn should decelerate economic growth.

 

Yet the only thing that matters to investors is whether they should stay the course with a diversified stock mix of emergers, developed-world foreign stocks and U.S. stocks. Or is it time to abandon ship? The answer is neither.

 

You have to think in terms of maintaining a diversified mix of stocks and a diversified mix of income producers, to the extent that it remains sensible. However, you shouldn't expect to achieve superior results through buying, holding and forgetting. Nor should you sell everything that underperforms.

 

For example, let's say you read The Economist's story last October headlined "How India Will Outpace China." And let's say the information inspired you to buy shares of WisdomTree India (EPI). You may have acquired your shares at a price of $28 while the ETF was still above its 200-day trend line. Yet a reasonable stop-limit loss order at $25 could have acted as your protection against further deterioration. Or perhaps a sell order when EPI dropped below the 200-day ($24.50) could have acted as your guide.

 

If you didn't have an exit strategy, however, you'd still be holding a fund that is now down 18.2% from your purchase point, and you'd have no idea what to do next.

Pruning for protective purchases is sensible. It is how you avoid the bulk of any disaster, including the way many investors minimized the risks of 2008's systemic collapse.

 

By the same token, though, you don't sell all of your positions because they're "underachieving." Vanguard Emerging Markets (VWO) may be treading water since it surpassed $48 in November 2010 and again in January 2011. That said, it has neither dropped 10%-12% from its peak nor fallen below its 200-day trend line. The longer-term uptrend should give you the conviction to hold on to your broad-based emerging-market ETF, even though it isn't currently rockin'-n-rollin' like the Dow or the Nasdaq ($COMPX).

 

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