Is It Risk-on or Risk-Off?

11/26/2012 7:00 am EST

Focus: ETFs

Sentiment remains depressed as economic turmoil in the Eurozone continues to dominate headlines, and it doesn’t help that Japan is now experiencing a political crisis in addition to an economic one. Throw in the fiscal cliff, and Greg Harmon of Dragonfly Capital shares a potential trade waiting in the wings.

Many traders and investors use the relationship between emerging markets (EEM) and the S&P 500 (SPY) as a gauge of risk taking. Recently many have been lauding the emerging markets over the US market, but not much has been happening.

Looking at the chart below, this metric is at a crucial level. After moving steadily higher since late 2010, the ratio of the S&P 500 to emerging markets has been consolidating since June. This is forming a descending triangle and a break below the base would trigger a target nearly 10% lower at 3.05. A relative move by emerging markets of 10% against the S&P 500.

Click to Enlarge

At the extremes, this would take the Emerging Market ETF from its current level of 40.80 to 44.88, or the S&P 500 lower to 1237. Of course this could end up rebounding to the top of the triangle and breaking higher, into a bullish continuation. There is no play to be made until it breaks down through the triangle. The Relative Strength Index (RSI) and Moving Average Convergence Divergence indicator (MACD) support the break lower so focus there.

By Greg Harmon of Dragonfly Capital

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