ETFs

Sovereign Debt Could Damper ETFs

By Kevin Grewal, Editorial Director

The most recent worries about Dubai World and its ability to pay its debts has opened up a whole new can of worms and have many questioning whether or not the delinquencies of sovereign debt could potentially put a damper on a global economic recovery.  

Sovereign debt is the total amount of sovereign bonds, which are bonds issued in foreign currencies, owed to bond holders.  In general, the issue of delinquencies in these bonds, or type of debt, arises when a nation cannot afford to repurchase the necessary foreign currency when the bonds mature and repayment is due.

From a macro perspective, if sovereign debt defaults get out of control, then the flow of global credit is in jeopardy, which will likely put a damper of the entire global financial system.  In addition to this, there are the potential consequences of having political instability and social unrest, which will likely further weaken the global financial system.

With this in mind, it is important to be mindful of the nations which are viewed as being at-risk of defaulting.  One such nation is Mexico, which the S&P recently downgraded in debt ratings citing concerns in the manners at which the nation is raising money.  Additionally, Mexico’s attempts to increase economic efficiency are likely to not compensate for its weak fiscal policy. 

Other nations include Argentina and Ecuador which are have debt ratings of B and CCC, respectively.  What this translates to is that both nations are financially vulnerable, are seeing debts starting to approach the size of their total economy and are likely to find it difficult to meet their financial obligations.

With this in mind, some equities that may be affected by delinquencies in sovereign debt include:

  • the iShares S&P Latin America 40 Index (ILF), which has more than doubled from a March low of $21.64 to close at $46.78 on Thursday.  Mexico comprises nearly 22% of the total assets of ILF.
  • the iShares MSCI Emerging Markets Index (EEM), which is up 102% from a March low of $19.94 to close at $40.25 on Thursday.  Nearly 26% of EEM’s asset base is allocated to Latin America.

To help mitigate the risks involved with investing in these equities the use of an exit strategy is of utmost importance.  According to the latest data from www.SmartStops.net, an upward trend in the mentioned ETFs is likely to come to an end at the following price points: ILF at $45.73 and EEM at $39.38.  These price points change on a daily basis with market fluctuations and updated data can be found at www.SmartStops.net

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