A COMPARISON OF GLOBAL STOCKS SHOWS UNUSUAL DIVERGENCES -- MONEY MAY BE STARTING TO ROTATE OUT OF THE U.S. INTO FOREIGN STOCKS, ESPECIALLY EMERGING MARKETS -- EMERGING MARKETS ISHARES MAY BE BREAKING OUT TO THE UPSIDE
COMPARISON OF GLOBAL STOCK INDEXES ... While U.S. stocks are starting to struggle on fears of high valuation, some money is starting to flow into foreign stocks that show better value. Chart 1 shows the S&P 500 doing better than foreign developed and emerging markets since the October 2011 bottom. During that time span, the S&P 500 (representing the U.S.) gained 65% versus a 54% gain in the EAFE Index (representing developed markets in Europe, Australasia and the Far East). The worst performer by far have been Emerging Market iShares which gained only 28%. Given the historic tendencies for global stocks to be more highly correlated, the unusual disparity between global markets is likely to correct itself. That process may have already started. During the first four and half months of 2014, emerging markets have been the strongest performers and the U.S. the weakest. The EEM has gained 2.7% versus 2% for the EAFA and 1.6% for the SPX. Expectations for more aggressive easing in the eurozone (which might eventually include quantitative easing) should provide a tailwind for European equities -- at the same time that the Fed is winding down its bond buying program. My main interest in this message, however, is emerging markets. Not only are they starting to show better relative performance, but their chart patterns look more promising.
Chart 1
EEM MAY BE EMERGING FROM BULLISH TRIANGLE... The weekly bars in Chart 2 show that Emerging Market iShares (EEM) have been trending sideways since spring 2011 between two converging trendlines (green lines). Chartists will recognize that pattern as a "symmetrical triangle". Since the triangle is a "continuation" pattern, and the trend for the EEM was up prior to 2011, that makes this a bullish triangle. The chart also shows the EEM very close to breaking above the upper trendline (green circle). That would constitute a bullish breakout for the entire asset class. A close above its October 2013 intra-day high (43.52) would confirm that bullish breakout even further. Notice also that the EEM/SPX relative strength ratio (solid red line) has risen above a falling trendline extending back to the end of 2012. That shows emerging markets starting to gain ground on U.S. stocks during 2014. [Emerging markets are also gaining on foreign developed markets].
(click to view a live version of this chart)
Chart 2
EMERGING MARKET GAINS SINCE MARCH 4... Interestingly, money started moving into emerging markets during the first week of March when U.S. small cap and Nasdaq stocks started to weaken. Since March 4, U.S. small cap stocks have fallen nearly 10% (while the Nasdaq Composite has lost -6%). Chart 3 shows emerging market ETF winners since March 4th to include India, Brazil, Taiwan , South Korea , China, and Russia . It seems reasonable to assume that some money leaving the U.S. is moving into those emerging markets. Chart 3 also shows that Russian stocks have stabilized after falling in February and early March on Ukraine tensions. That has helped stabilize the EEM. Two other markets worth close watching are China and India.
Chart 3
CHINA ISHARES ARE FIRMING UP ... Since China carries the biggest EEM weighting (17%), its direction carries a lot of influence on the EEM. The daily bars in Chart 4 show FTSE China iShares (FXI) ending the week at the highest level in a month. The FXI still has a ways to go to turn its chart trend up, but its pattern of "rising bottoms" since March (rising trendline) is encouraging. Even more encouraging chart action can be seen in South Korea (EWY) and Taiwan iShares (EWT) which are at or near new 52-week highs. South Korea and Taiwan are the second and third biggest countries in the EEM with weightings of 16% and 12% respectively. India is even more encouraging.
(click to view a live version of this chart)
Chart 4
INDIA ETF SURGES ON ELECTION RESULTS... Chart 5 shows the WisdomTree India Earnings ETF (EPI) leaping this week to the highest level since mid-2011. And it did so in heavy trading. The India/ EEM relative strength ratio (below chart) turned up in similar fashion. Indian stocks had been rising in anticipation of an electoral victory by the country's opposition political party running on a pro-business platform. Its overwhelming victory announced near week's end catapulted Indian stocks sharply higher. The line on top of Chart 5 shows the Bombay 30 Sensex Index ($BSE) hitting a record high. The reason why the BSE is so much stronger than the India ETF is due to currency fluctuations. The BSE is quoted in its local currency (the rupee) which has been weak since 2010 versus the U.S. dollar. The EPI is quoted in a stronger U.S. dollar. An entity quoted in a stronger currency (the dollar) will underperform one quoted in a weaker currency (the rupee). But those trends are now changing in favor of the rupee and the India stock ETF.
(click to view a live version of this chart)
Chart 5
INDIAN RUPEE HITS ONE-YEAR HIGH... Another sign of renewed confidence in India is the sharp 2014 rally in its currency. The green line in Chart 6 shows the WisdomTree Dreyfus Indian Rupee ETF (ICN) surging to the highest level in a year. The black line is a relative strength ratio of the India ETF (EPI) divided by the Bombay Sensex Index ($BSE). While the rupee lost 20% of its value between 2010 and last autumn, its stock ETF underperformed its cash index (falling ratio). Those trends have reversed. The EPI/BSE ratio has turned up this year along with the currency. This year's 10% gain in the rupee has helped the India ETF (EPI) outgain the Bombay Sensex Index by a factor of 25% to 14%. A stronger rupee makes the India stock ETF a stronger bet.
(click to view a live version of this chart)
Chart 6
GLOBAL ROTATION FROM GROWTH TO VALUE... One of the main themes in the U.S. market this year has been the rotation out of overvalued growth stocks into undervalued (or safer) value stocks. Value stocks generally include large blue chip stocks that pay dividends. That includes consumer staples, utilities, and REITs which are also defensive in nature. That same rotation may be starting on a global basis. The U.S. market has been the strongest in the world (and probably the most overvalued). Foreign stocks appear to represent better value. That's especially true of emerging markets which have been the weakest in the world. That may be changing. Chart 7 applies traditional chart analysis to a "ratio" of Emerging Markets iShares (EEM) divided by the S&P 500 since 2006. The rising ratio leading into 2010 favored emerging markets. The falling ratio since late 2010 has favored the U.S. The ratio, however, has reached potential chart support formed during the financial crisis of 2008 and is starting to bounce (see circles). That suggests that the U.S./EEM relative strength pendulum has swung too far to the downside and may start to swing back in favor of emerging markets. Right now, they appear to offer the world's best value. One additional factor favoring emerging markets is the 2014 drop in bond yields in developed markets. That helps drive funds back into higher-yielding emerging market assets.
(click to view a live version of this chart)
Chart 7
RUSSELL 2000 IS TESTING FEBRUARY LOW... All eyes were focused on the Russell 2000 Small Cap Index ($RUT) on Friday. Chart 8 shows why. The RUT was in the process of testing important chart support at its early February low. Thursday's intra-day low of 1082 exactly matched the intra-day low of early February (see circles). A close below that support line would have signalled a bigger breakdown in small caps, and the rest of the market as well. The good news is that the RUT held that support level, and the rest of the market experienced a relief bounce on Friday. The bigger question now is whether or not the RUT can hold that support level and start to reclaim some overhead resistance levels. It remains below its 200-day moving average. As I suggested at midweek, the direction of the RUT from here will most likely determine the direction of the U.S. stock market. The fact that stocks have entered the seasonally dangerous month of May also adds to traders' overall caution as they've rotated out of small caps and into larger and more defensive stocks.
