International ETFs are surging to start 2023, but investors should brace for volatility

Published Fri, Jan 13 202312:42 PM ESTUpdated Fri, Jan 13 20233:00 PM EST

Jesse Pound @/in/jesse-pound @jesserpound

The first two weeks of the new year have seen a nice recovery for U.S. stocks, but it's not keeping pace with the sharp moves seen around the globe. Exchange-traded funds tracking the stocks of many other countries have outrun the S & P 500's advance of 3.6% so far this year, including those for China , Brazil , Mexico and Germany . Many Wall Street pros have started to look overseas for returns in anticipation of a falling U.S. dollar, China's reopening and a potential rebound by European economies. Bernstein strategist Sarah McCarthy said in a note to clients Monday that her team preferred Europe to the U.S., and Asian equities over both. "We believe Asian markets are well positioned vs. developed markets as we expect China re-opening to be a key driver, which would benefit even Asia ex China markets," McCarthy wrote. Broadening that out even further, emerging markets in general are a favorite of many investment strategists. "A relative improvement in the growth-inflation outlook, a peaking U.S. dollar, more attractive returns and favorable technicals should help EM assets to recover some of their losses of the past two years," Murat Ulgen, HSBC's global head of emerging markets research, said in a note to clients Wednesday. But emerging markets can be tricky for investors, and volatile. Individual country funds can see big swings based on their political situation or a narrow market, similar to what happened with iShares MSCI Turkey ETF (TUR) , which nearly doubled in 2022. That fund has retreated more than 9% so far this year. Many countries' economic fortunes are also closely linked to the U.S., making true outperformance difficult if a recession hits. "We believe it is too soon to be completely risk-on as the risk of a global recession is still looming and all Asian markets haven't priced-in a recession," McCarthy said. "There are markets like India, Indonesia, Thailand that haven't even priced in a slowdown, so global recession is a bigger risk for such markets along with key export-driven sectors." Strategas Securities ETF strategist Todd Sohn, in particular, laid out wild swings and downside risks for China ETFs in a note Tuesday, pointing out that the MSCI China index has an average intrayear correction of -30% over the past 30 years. Additionally, the top 10 largest China ETFs have burned through more than $5 billion in cash combined over their various lifetimes, according to Strategas. "Timing them is basically impossible," Sohn said. "You have to be really good to be able to get both the entry and exit right. I have a hard time thinking of China as an investment as opposed to developed countries." The case for the U.S. dollar is also not straightforward. While the Federal Reserve rate hikes that drove the greenback higher are expected to pause this year, the Dollar Index has already dropped 8% since Nov. 1. Goldman Sachs Investment Group said in its 2023 outlook Friday that its base case is for a "negligible increase" in the dollar this year rather than continued declines. .DXY 3M mountain The U.S. dollar has fallen from its highs of late last year. Another way for investors to play a recovery in emerging markets, with more dispersed currency and political risk, could be sector funds tied to commodities. The SPDR S & P Metals & Mining ETF (XME) , for example, is up 11.4% year to date, and includes companies that operate mines around the world, including in Asia and South America. "I can buy ETFs that have exposure to say BHP, Rio Tinto, Anglo American, Glencore," Sohn said. "That's the easier and probably more effective way, and I'd like to think less volatile, than playing China directly." — CNBC's Michael Bloom contributed to this report.