For US traders, developing-country stocks have been a surprising source of returns as Donald Trump’s trade war roiled the S&P 500 Index. But if options are any guide, that outperformance may soon be a thing of the past.
With President Trump’s 90-day pause on reciprocal tariffs slated to end in early July, speculators are now bracing for more turbulence in emerging markets. An ETF tracking the segment has rallied 14% this year, beating the S&P 500 by the most since 2009. Open interest in put options on the iShares MSCI Emerging Markets ETF (EEM) is hovering close to the highest since December relative to bullish call contracts. Rising open interest means new positions are being added in a particular contract.
Matt Maley, chief market strategist at Miller Tabak + Co., expects a short-term decline in emerging-markets stocks relative to the S&P 500.
“It’s getting extended and a little bit overbought,” he said in an interview, referring to EEM. On Monday, the ratio of bearish put options on the ETF climbed to the highest against bullish calls since December.
Still, a significantly weaker dollar could continue to benefit EM companies since many of their costs are denominated in the US currency. And developing-nation stocks still offer cheaper valuations than their US counterparts.
For EM stocks, “you probably can buy them a little bit cheaper in the second half of June,” Maley said. As for the S&P 500, earnings estimates “need to be growing a lot more than they are to justify a further rally from today’s expensive level,” he added.
Erratic Moves
Erratic moves in US trade policy — followed by subsequent spikes in Treasury yields — have triggered sharp gyrations in the equity market and a significant decline in the dollar, to around the weakest in three years.
The US is “behaving very much like how an emerging-market economy would,” Mandy Xu, head of derivatives market intelligence at Cboe Global Markets, told Bloomberg TV on Tuesday. “Higher bond yields, but a weaker dollar — you are seeing that reflected in the equity volatility market.”
In response, investors have increasingly rotated into EM funds to limit exposure to those dramatic shifts. The VIX, a measure of volatility in the S&P 500, has been higher than the Cboe EM ETF Volatility Index for all but six of the last 54 trading days. On Thursday, the VIX was at 18 points, while its EM counterpart hovered at 15 points.
Josh Silva, managing partner and Chief Investment Officer at Passaic Partners, said that tariff uncertainty has been a stabilizing force for EM assets as a whole. The outcome of trade talks with the US could vary for the 24 countries in the MSCI EM Index, which includes stocks from from Brazil to the UAE.
“If China wins and India loses? One is going to be up, one is going to go down,” Silva said in an interview. “All of it messes up in a soup and you get a nothing outcome.”
Positive progress on trade could give the S&P 500 a boost. The US this week said it has made significant headway with China on trade talks, and a firm agreement could help to erase some of the uncertainty weighing on US assets. Plus, investors are pricing in two US interest-rate cuts this year and banking on Trump’s tax bill to boost corporate earnings and domestic growth.
Current momentum in US stocks could also shrink the EM advantage. The S&P 500 is trading near a record high, and institutional investors may need to abandon their underweight positioning in US equities to outperform benchmarks, opening the door for further gains, Barclays Plc and JPMorgan Chase & Co. say.
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