2017: Goldilock's for EM, buy EEM US

We said:

Now that we see the risk of tighter US policy and a rising dollar pushed out to next year, we think it’s time for EM to catch up.

Since Fed policy started to tighten (the low in the Wu-Xia shadow fed funds rate was May 2014), investment in the EEM ETF – a US-listed fund which tracks the MSCI EM Index – has lagged investment in the SPY ETF. The SPY tracks the S&P500 and its size is a proxy for the broad rise in investable assets in the US. In other words, investors are relatively underweight EM.

Valuations also support owning EM rather then DM equities. The forward p/e for MSCI EM is 12.6x compared to 17.3x for MSCI DM. The discrepancy in EPS growth expectations is slightly lower, at 21% for EM vs 24% for DM, but EPS expectations have been rising more rapidly for EM than DM – another positive signal for EM outperformance from here on. Although the EEM ETF includes exposure to China, the slowdown in Chinese growth that we expect should not become a headwind. 

Finally, the decision by MSCI to include 222 China A-Shares in its EM index may not deliver an immediate boost to EM equities. At 0.73% market cap weighting, the potential inflow is around one-quarter of average daily volume in Shanghai and Shenzhen. All else equal, it is likely to mean only reallocation rather than new flows. But it is a net positive for sentiment towards EM assets and may highlight the degree to which some investors remain underweight.

We buy the EEM US equity ETF at 41.10 and set our t/p at 44 (near the previous high) with a stop at 39.50 (below the 100d moving average).

Outcome:

On 13 September we increase our target to 49.00 and raise the stop loss to 43.70, locking in 6.3% of profit since inception. 

On 11 October we raised our stop loss to 44.40, locking in at least 8% profit. 

On 1 November we raised our stop loss to 45.20, locking in a minimum 9.5% profit. 

On 22 November we raised out stop loss to 45.80, locking in over 10% profit. 

On 4 December our target of 49.00 was hit and we closed the trade for a total profit of 11.4%. 

 

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