Normally considered the first to collapse in an economic slowdown, smaller and more economically sensitive emerging market ETFs are actually resisting the worst of the global market’s recent losses. This is not just a liquidity issue.Over the last month, the large-cap EEM (quote) fund has dropped like a rock, shedding 10% of its value as the “risk off” trade cements its hold on market psychology.
What’s the secret of small-cap stamina in the face of China angst and the euro’s pain?
If EEMS was an individual stock, we might suspect a lack of liquidity keeping traders who want to dump shares from doing so. Normally, EEMS trades only around 5,000 shares a day and has lately seen that turnover fade to a 1,000-share trickle — barely moving 0.1% of the float on a given session.
While that could indicate a buyers’ strike trapping existing shareholders in the fund while the paper losses in the portfolio build up, the reality is completely different.
Nervous traders have actually tried to get ahead of the curve, dumping as much EEMS as they can. In the aftermath, the fund is actually trading at close to a 2% discount to its underlying assets.
EEM, interestingly enough, is trading at a 1% premium above its constituent stocks, so if anything, sentiment on large emerging market companies is still a bit better than the situation really justifies.
And we can see the relative strength of global small-cap shares in the MSCI indices on which these funds were built. The indices reflect true native-market performance, so they’re not constrained by issues of liquidity in any U.S.-traded investment product.
It turns out that since the start of May, the MSCI EEM Small-Cap Index is down 7.50% in dollar terms. Its large- and mid-cap counterpart, the standard EEM, is indeed down close to 10%.
Going back, we see small emerging stocks outperforming in other periods of global market crisis like last summer. Both ends of the equity asset class lost ground and the spread was generally small — 1% to 2% — but if you’re looking for a safe haven in the emerging markets, you might want to rethink your love of the giants in EEM.
Remember, a lot of those companies are exporters, especially exporters of commodities. Those are the true economically sensitive names to suffer when the global economy turns south. And as you can see, the 1% to 2% adds up.