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Emerging-Market ETFs Are Showing Excellent Strength

While initially less enthusiastic about getting whipsawed from emerging-market equities, I have been impressed with the relative strength in the iShares MSCI Emerging Markets ETF (EEM) and Vanguard Emerging Market ETF (VWO) over the last five months as well. Since hitting a low in February, VWO has gained 18% and significantly bested the 11.15% return of the SPDR S&P 500 ETF (SPY).

The important breakout for VWO and EEM was to push back above the 2013 high and continue to make positive headway this year. More recently, these ETFs have held up better than other momentum areas such as social media, biotechnology, and solar stocks all of which have experienced another round of selling pressure. Furthermore, this same trend and strength has also been confirmed in smaller regional companies according to the SPDR S&P Emerging Market Small Cap ETF (EWX).

That speaks volumes about the resilience of emerging-market stocks at this juncture and the demand for undervalued global opportunities when compared to high-priced domestic equities. In addition, we have yet to see a convincing return of asset flows to this space, which is a positive indicator of the potential upside for a reflation trade in emerging-market countries.

VWO is still on in the top 10 list of ETF outflows for 2014 with $2 billion in redemptions, but the majority of that damage was done in the first quarter of the year. Since March, this ETF has seen steady inflows that suggest the tide may have turned.

I currently own VWO for my growth portfolio because of its much lower expense ratio and its outperformance over EEM so far this year. VWO only charges an annual fee of 0.15% versus 0.67% for EEM. That translates to a pickup of 52 basis points in total return, with all other factors being equal.

While the current valuations in both stocks and bonds are not nearly as attractive as they were six months ago, I will continue to hold emerging-market positions for clients as long as they exhibit positive price momentum. My risk management strategy is defined by a stop loss to guard against a reversal in both these asset classes as a function of trading discipline. In addition, I am leaving open the door to add to these holdings over time if they continue to demonstrate alpha over other global investment themes.

At the time of publication the author had positions in EMB and VWO.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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