Emerging Market Hedges Show Risk Dwindling Versus U.S.: Options
By Joseph Ciolli
(Bloomberg) — Costs to protect against losses in emerging
market stocks have dropped to the lowest level in more than two
years compared with U.S. equities, a sign investors expect
developing nations to outperform.
The Chicago Board Options Exchange Emerging Markets
Volatility Index has fallen 30 percent from a 16-month high
reached in October. Last month, the gauge reached the lowest
level since 2012 versus the VIX gauge of Standard & Poor?s 500
Index contracts.
Valuations for U.S. equities remain close to the highest
level since 2010 even as American investors grapple with
uncertainty over mixed economic data. Meanwhile, emerging
market stocks have fallen so much over the past five months that
investors are questioning how much lower they can go.
?There?s some concern that U.S. stocks are very extended
from a valuation standpoint, while EM stocks are not, since
they?ve been in somewhat of a downturn over the last couple
quarters,? Phil Orlando, who helps oversee about $400 billion
as chief equity market strategist at Federated Investors Inc. in
New York, said in a Jan. 29 phone interview. ?The valuation
imbalance is contributing to this disparity in the VIX.?
Since the start of September, the MSCI Emerging Markets
Index has plunged 10 percent, while the S&P 500 has increased
1.9 percent. For the full year 2014, the emerging-market gauge
slipped 4.6 percent as its U.S. counterpart added 11 percent.
Stock Valuations
As the S&P 500 has climbed higher, so has its price-to-
earnings ratio. On Dec. 26, the S&P 500 traded at 18.4 times
profit, the highest since March 2010. The ratio currently sits
at 18, while the emerging-market index is priced at 12.4 times
earnings.
The valuation spread between the S&P 500 and the MSCI EM
Index averaged 5.88 from the start of December through January,
the most for any two-month period since 2008, data compiled by
Bloomberg show.
The emerging markets VIX, at 22.42, is about 5 points
higher than the U.S. volatility gauge. The difference shrank to
0.4 points on Jan. 16, the lowest since December 2012.
?The difference in the two VIX indexes probably reflects
how well the U.S. has done and how poor emerging markets have
done relative to that,? John Manley, who helps oversee about
$233 billion as chief equity strategist for Wells Fargo Funds
Management in New York, said in a Jan. 30 phone interview.
?Emerging markets are cheaper and people don?t think there?s as
much room to run down, and therefore not as much need to protect
against losses.?
Mixed Data
Recently released U.S. economic data has been mixed, which
is contributing to investor uncertainty and spurring more demand
for protection against price swings, Manley said.
Gross domestic product grew at a 2.6 percent annualized
rate after a 5 percent gain in the third quarter that was the
fastest since 2003, Commerce Department figures showed last
week. The median forecast of 85 economists surveyed by Bloomberg
called for a 3 percent advance.
Another report showed American consumer confidence reached
an 11-year high in January as a strengthening labor market and
plunging gas prices kept households looking on the bright side.
Crude oil prices hovering near the lowest level in six
years are also contributing to unpredictable stock price
movement in both developed and emerging markets. The commodity
plunged 55 percent through January after reaching a nine-month
high in June.
The MSCI EM Index has trailed the S&P 500 over that period,
falling 7.9 percent while the benchmark U.S. index added 1.6
percent. The benchmark emerging-market gauge fell to the lowest
level in 16 months on Dec. 16, capping off eight straight days
of declines, on data signaling a contraction in Chinese
manufacturing.
Global Concerns
While concern over the pace of economic growth in China
weighed on investor sentiment amid the MSCI EM Index drop,
Russia?s decision to unexpectedly raise its benchmark rate also
roiled emerging-market shares.
Economists surveyed by Bloomberg have taken notice of the
turmoil and lowered their growth forecast for BRICS nations —
Brazil, Russia, India, China and South Africa. They?re projected
to post gross domestic product growth of 5.2 percent for 2014,
which would be the lowest since 2009, Bloomberg data show.
?We remain cautious on EM equities as we move through the
first quarter of 2015,? Brown Brothers Harriman & Co.
strategists led by Marc Chandler wrote in a note on Tuesday.
?The MSCI EM Index has gained some traction but is not far off
the lows. The asset class remains vulnerable to further
selling.?
Oil Effect
Still, emerging markets stand to benefit from lower oil
prices in the coming months, according to Paul Christopher, the
St. Louis-based head of international strategy for Wells Fargo
Investment Institute, which oversees $1.6 trillion.
The MSCI EM Index is already picking up momentum versus
developed stocks, gaining 0.6 percent in January, compared to a
3.1 percent loss for the S&P 500.
Investors are also starting to trim bearish bets on an
exchange traded fund tracking emerging-market stocks. The ratio
of puts to calls on the iShares MSCI Emerging Markets ETF slid
3.5 percent last week, the first five-day decline of the year
and the biggest since early November.
?The emerging market is already worn-out, and that
mitigates volatility,? Matt Lloyd, the chief investment
strategist at Advisors Asset Management Inc. in Monument,
Colorado, said in a Jan. 29 phone interview. His firm oversees
$14.2 billion. ?There?s a point to buying emerging markets at a