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Emerging Market ETF Signaling S&P Correction
12/06/2019 6:00 am EST
While the S&Ps have outperformed emerging markets, the EEM ETF has provided clues to corrections in the SPY over the last year, reports Joon Choi.
Since the sharp stock selloff in the fourth quarter of 2018, the S&P 500 Index (SPX) has bounced back sharply in 2019. The index is up 25.3% through November which is its best first 11-month return since 2013 when SPX gained 26.6%. Prior to that, you have to go all the way back to 1997 (29%) for a higher return. However, increased pessimism about a trade deal with China has led to a roughly 2% selloff from its record high on Nov. 27. Here we will discuss why the stock market may be poised for a pullback, albeit a modest one.
Emerging markets underperform
The iShares MSCI Emerging Markets ETF (EEM) has been underperforming the SPDR S&P 500 ETF Trust (SPY) since the third quarter of 2010. While EEM is flat since April 26, 2011, SPY has gained 173% for the same period. Furthermore, EEM has yet to record new highs after both ETFs notched record closes in January 2018. However, SPY has advanced 11.6% after its same peak last year (see chart below).
EEM diverging from SPY
Even though EEM has lagged SPY for most of last decade, it has been useful in spotting short-term stock weaknesses this year. Point A in Chart 2 below shows that as SPY was carving out new highs in April, EEM diverged from the U.S. stocks and fell; which led to a stock selloff (6.6% for SPY and 9.7% for EEM). Another negative divergence occurred in July which led to similar selloffs for both SPY and EEM; 6% and 9% respectively (Point B). The bearish pattern also formed in November and SPX is now 2% off the record highs.
Although emerging market stocks have not fared well versus U.S. stocks, they seem to offer a clue to when the stock market may experience short-term weakness. When EEM diverged from SPY on two occasions this year, it provided a buying opportunity for both ETFs. If past occurrences serve as a guide, we may see another 6% selloff in SPY and a slightly larger loss for EEM. The $296 level will serve as good support for SPY as it is a breakout retracement and an uptrend support level.
Joon Choi is Senior. Portfolio Manager/Research Analyst at Signalert Asset Management. Sign up here for a free three-month subscription to Dr. Marvin Appel’s Systems and Forecasts newsletter, published every other week with hotline access to the most current commentary. No further obligation.
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