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Beaten-up emerging markets could see more underperformance in 2017

Emerging market majorly underperform

The most popular emerging markets ETF, the EEM, has underperformed the S&P 500 by more than 12 percent in the fourth quarter alone, and could fall further into the new year.

The Asian-Pacific-focused ETF — whose top-weighted holdings include Samsung, Taiwan Semiconductors and Tencent Holdings — has taken a hit as U.S. domestic markets and the dollar have surged since the November election.

Yes, the EEM is up 8 percent this year, though its underperformance in the fourth quarter relative to the S&P 500 ETF (SPY) is its worst since the first quarter of 2013.

Rising interest rates and stronger dollar are of particular concern to Erin Gibbs, equity chief investment officer at S&P Global, noting the EEM's largest holdings are in Asia.

"We still think that they're probably going to underperform the U.S. markets. So for us, we're not as positive. I don't see it rebounding and taking over the U.S. markets," Gibbs said Wednesday on CNBC's "Trading Nation."

Certainly, she said, some emerging-market countries outperform, "but that's really up to an active manager, and definitely not this ETF."

The pattern of divergence between the EEM and the has grown since the election, but started in September 2014, said Max Wolff, market strategist at 55 Capital. He pointed to the rotation to U.S. stocks after the election spurred by dollar-denominated assets.

"We think the EEM is going to see a little bit of strength coming into the beginning of 2017 here," Wolff said Wednesday on "Trading Nation."

"That being said, we do think the EEM space is not done with some fundamental difficulties," he added. "We think the surging dollar and the rise in interest rates is going to put some pressure" on the EEM.

From a technical perspective, Matt Maley of Miller Tabak wrote in a Wednesday note that the EEM is testing lows it last saw in November, hovering just above $34.

A break below that level would be quite bearish for emerging markets, he wrote.

"In other words, it took a while for the strengthening dollar to have a negative impact on the EEM, but there is no question that it is finally creating some headwinds," Maley said.