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Because Markets Change: Emerging Markets

There’s a lot to like about emerging markets. Compared to established markets, emerging markets have faster growth, more favorable demographics, and access to natural resources. Given this, you might assume that emerging markets would be great investments. But they aren’t always the place to be.

When emerging economies are in favor, they have produced tremendous gains. The MSCI Emerging Markets Index, a market capitalization index that is designed to measure equity market performance in global emerging markets, gained over 100% from June 30, 2003 through December 31, 2008, while the S&P 500 gained just 1%. But markets change and in the last few years, emerging markets haven’t been strong performers. In fact, emerging markets were one of the worst performing areas in 2013, while U.S. indexes had terrific gains. The MSCI Emerging Markets Index lost 3.7% versus a gain of 32.3% for the S&P 500.

When We Invest in Emerging Markets and When We Steer Clear
Our Upgrading strategy seeks to participate in the gains from emerging markets when they are doing well and avoid the damage of emerging markets when they aren’t in favor.  Upgrading led us to invest the FundX Upgrader Fund (FUNDX) in emerging markets when they were leading, such as in 2003 through 2007, and to avoid emerging markets in the last few years.

Relative strength is a calculation based on the ratio between the return of one index versus another. It clearly identifies changes in market leadership. On page 11, we compared the relative strength of the MSCI Emerging Markets and the S&P 500.  When the relative strength line turns up as in 2003-2007, emerging markets are outperforming the S&P 500. When the line moves down as in 2008-2013, emerging markets are underperforming the S&P 500.

The orange bars represent the percentage of the FundX Upgrader Fund (FUNDX) that was invested in emerging markets over this 10-year period. Exposure to emerging market funds peaked around the end of 2010 at about 18% of the portfolio. FundX would never be 100% in emerging market funds, even when they are doing well. We limit our exposure to these volatile funds to a smaller percentage in order to manage the overall risk of the portfolio.

When emerging markets were outpacing the S&P 500 (when the relative strength line is heading up) in 2003 through 2007, FUNDX was fairly consistently invested in emerging markets funds and ETFs.  In the last few years as the S&P 500 has outperformed emerging markets (relative strength line sloping down), FUNDX had little exposure to no exposure to emerging market funds and ETFs.

Most areas of the market come in and out of favor over time, and we expect that emerging markets will eventually be a good investment again and when that happens, we’ll invest FUNDX in emerging markets funds and ETFs.  

But until then, we’re seeking to invest FUNDX in areas of the market that are performing better than emerging markets, areas like small-cap U.S. funds and tech-oriented NASDAQ funds. 

The orange bars shows the percentage of FUNDX’s portfolio that was invested in emerging markets over these last 10 years and the line chart shows relative strength. Relative strength is a way to identify changes in market leadership. Relative strength is calculation based on the ratio between the return of one index versus another. The chart above compared the MSCI Emerging Markets Index to the S&P 500 Index. When the relative strength line is heading up, the MSCI Emerging Markets Index is outperforming the domestic S&P 500 index. When the relative strength line is heading down, the S&P 500 is outperforming the MSCI Emerging Markets Index.

Performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance of the fund may be lower or higher than the performance quoted. Performance data quoted current to the most recent quarter- and month-end may be obtained by clicking here.

The MSCI Emerging Markets Index is a market capitalization index that is designed to measure equity market performance in global emerging markets. The S&P 500 Index is a broad based unmanaged index of 500 U.S. stocks, which is widely recognized as representative of the equity market in general. One cannot invest directly in an index.

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