Emerging markets have disappointed to far in 2019, but could be posed to make a move, says Marvin Appel.
I had expected 2019 to be the year of opportunity for emerging markets, but that hope seems to be receding. At the start of the year, my long-term asset allocation model which selects either the iShares Emerging Markets Index ETF (EEM) or the S&P 500 SPDR (SPY) came within 1.2% of switching to EEM. That means that if EEM had outperformed SPY in 2019 by 1.2% or more at month-end, the longer-term trend would switch to favoring emerging markets over U.S. equities. Such a change in leadership seemed possible after the fourth quarter of 2018, when emerging markets held up much better than the S&P 500 Index.
However, so far this year EEM is more than 3.5% behind SPY. The most recent technical picture is not looking too promising for EEM. For example, the chart below shows that there is a downtrend in the EEM/SPY ratio, meaning that SPY has been steadily leading EEM over the past four months. The price of EEM has formed a negative divergence with its MACD: Price barely made a succession of new highs in February-March but MACD has been making progressively lower peaks.
In the Feb. 28, 2019 issue of Systems and Forecasts, Joon Choi noted that the Chinese equity ETF (FXI) had reached three standard deviations above its mean. Historically, FXI has lost momentum and underperformed SPY after getting overbought. Since FXI and EEM have performed very similarly over the past three years, this would suggest continuing drag on EEM as well (nearly 33% of EEM is in Chinese stocks, and another 25% in Taiwan and Korean stocks that are closely linked with China).
The bullish case for EEM is that the U.S. Dollar seems to have exhausted most of its upside potential. A weaker dollar would benefit emerging market economies in a number of ways, including easing the burden of servicing debt denominated in U.S. dollars and increasing demand for commodity exports, which are largely priced in dollars. With the recent move, EEM may be well-placed vs. the SPY so traders should continue to follow the EEM and watch for an eventual opportunity to reallocate some assets from SPY to EEM.
