Emerging Markets Face Key Test

05/20/2011 11:10 am EST

Focus: ETFS

Thomas Aspray

, Professional Trader & Analyst

Wall Street seems to be turning bullish on emerging markets, but the chart action for one of the primary emerging markets ETFs shows that there’s still cause for concern.

Inflation fears have dampened the interest in many of the emerging markets over the past few months. Many investors have also moved to lower risk in their portfolios as we approach the end of QE2.

A recent report from Birinyi Associates detailed how the major Wall Street firms feel about emerging markets. Their analysis showed that the outlook for many of the markets—including China, Malaysia, Singapore, Thailand, Turkey, and Brazil—had improved from earlier in the year. Brazil was the most favored market.

See also “Unloved Emerging ETF Shocks the Street

Over the years, I have often found that my opinion has been quite different from that of the big Wall Street firms, and as a result, the almost unanimous bullish outlook for Brazil has me concerned.

I have been closely following the action in the emerging markets, and my volume analysis for several of the emerging market ETFs suggests that the action throughout the next week or two will be critical. The improved technical outlook for the US stock market should be supportive for the emerging markets.

Click to Enlarge

Chart Analysis: The widely watched iShares MSCI Emerging Markets Index Fund (EEM) had dropped down to retest its breakout level (line a) in mid-April before making marginal new highs in early May at $50.43.

  • The correction from the highs has been very sharp, as the April lows have been broken with a low this week of $46.40
  • The weekly uptrend, line b, has now been reached with major support at $44.25
  • The weekly on-balance volume (OBV) did not confirm the May highs, as it formed a negative divergence, line c. The OBV is now trying to turn up from support at line d
  • The daily OBV (not shown) does look much better, but is just a bit below its weighted moving average (WMA)
  • There is short-term resistance now at $48-$48.50 and a close above $49 will suggest that the correction is over

The WisdomTree Emerging Markets Equity Income Index (DEM) looks better than EEM technically, and many find its current 3% yield quite appealing. DEM made new highs in early May at $64.86, but it has now pulled back to support in the $60-$61 area (line e).

  • The rising 40-week moving average (MA) is at $58.22 with major chart support now at $54.50-$55.50 (line f)
  • The weekly OBV failed to confirm the recent highs, as it formed lower highs, line g, before plunging back to its long-term uptrend
  • Clearly, the selling at the highs was quite heavy, which is not a positive sign. The daily OBV (not shown) is negative
  • Initial resistance stands at $63.50, and this level needs to be overcome to suggest that the correction is over

What It Means: Though in some cases the daily volume of these emerging market ETFs looks better, the longer-term divergences in their weekly OBV readings is clearly a cause for concern.

The sentiment picture does favor the emerging markets, as does the dollar’s long-term downtrend, but as I noted yesterday (see “Strong Stocks for a Weak Dollar”), there is the possibility that the dollar index could bottom out in the next few weeks.

I still think there is a place for emerging market exposure in investor portfolios, but I would suggest limiting that exposure to less than 10% unless the portfolio is very aggressive. The technical action of DEM looks the best to me currently, while the action in EEM is the most concerning.

How to Profit: For those with no exposure in emerging markets, I would buy DEM at $61.50 or better with a stop at 58.88 (risk of approx. 4.2%).

Related Reading: See “Unloved Emerging ETF Shocks the Street” for a country-specific ETF that is performing well but not highly favored by investors or the Street.

Portfolio Update

A brief review and update on previous positions in these emerging market ETFs:

iShares MSCI Emerging Markets Index Fund (EEM): Buyers should be 50% long at $48.48 and 50% long from $47.64 with a stop at $45.88. On a move $48.40, raise the stop to $46.63 and sell half the position at $50.10.

WisdomTree Emerging Markets Equity Income Index (DEM): Buyers should be 50% long at $60.68 and 50% long at $59.72. The stop was raised to $59.76 on the move above $64.82.

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