Will the Giant Trading Range for the Emerging Markets ETF be Resolved on the Upside or Downside?

• China, Taiwan and South Korea digesting gains following upside breakouts.
• India, Russia, and Brazil face technical challenges.
• The counter-cyclical commodity rally may well be over.

Emerging Markets

The MSCI Emerging Markets ETF, the EEM, has been in a large trading range during the last few years, as you can see from the upper panel in Chart 1. Since global equities have been rising during that period the relative strength line has been in a full-fledged retreat and that downtrend remains intact. Long-term momentum, in the form of the KST, often provides us with a clue as to the future direction of a market. In the case of the EEM we see that both the absolute and relative KSTs are (bearishly) below their moving averages, so it would not take much in the form of strength to reverse these trajectories. The one thing that stands out in the chart is that the next major move is likely to be signaled by a resolution of that trading range.

Chart 1

If it is going to be on the upside Chart 2 suggests that it will be later rather than sooner. That’s because the price of EEM has completed a small head and shoulders top and violated its intermediate up trendline. Note that the Emerging Market Diffusion Indicator has already crossed below its moving average from an extended level. This action also supports the idea of lower prices.

Chart 2

A quarter of the ETF holdings in EEM are in China and another 25% is exposed to Taiwan and S. Korea. Another 23% embraces other BRIC countries, namely India, Brazil, Russia and S. Africa. Charts 3-8 represent the bulk of these markets. China was the first to break out and is still enjoying a couple of bullish but by no means overextended long-term (primary trend) KSTs. The short-term chart (Chart 4) indicates the potential for a small head and shoulders top to be forming. The negative daily KST supports the idea of additional corrective activity.

Chart 3

Chart 4

Taiwan and South Korea recently experienced upside breakouts and are now falling back to support in the form of their extended breakout trendlines. A quick turn around seems unlikely because their KSTs are also in a negative mode.

Chart 5

Chart 6

Other emerging markets look somewhat challenged. India, Chart 7, for instance, has violated a bull market trendline on both an absolute and relative basis. Both KSTs remain in a positive mode but are nevertheless close to triggering sell signals.

Chart 7

Russia, Chart 8, has been rising recently but has run into resistance. Note that the KST is also in a negative mode. Chart 9 shows that the RSX is very closely tied in to the performance of the oil price. It would be nice to be able to say that one leads the other but sometimes oil leads, as at the 2008 bottom and sometimes the RSX goes first as at last summer’s breakdowns. If the RSX could break above the resistance trendline that would probably be pretty bullish for oil, given this close relationship. On the other hand if, as seems likely, the RSX falters from here it could be a sign of oil ending its bear market rally.

Chart 8

Chart 9

Finally, Brazil in Chart 10, remains in a downtrend on both an absolute and relative basis. Since both KSTs are negative there is little to get excited about.

Chart 10

To some extent grouping all these countries into one index and expecting them to perform in a similar fashion is a mistake. Earlier in this century it made sense, but in recent years their performance has differed considerably as you can appreciate from the various charts. Chart 11 compares two BRIC countries, China and Brazil. Note that the 2008-09 period experienced a couple of 50% moves interspersed with a doubling. In the 2014-2015 period Chinese performance almost reached a tripling over that of Brazil. Agreed these are two extremes but this differing performance shows the necessity of careful selection.

Chart 11

Commodities

Chart 12 compares the CRB Composite ($CRB) to its 12-month MA and long-term KST. The green arrows show when both series are above their respective moving averages, which are 12-months for the Index itself and 9-months for the oscillator. The red arrows indicate when both series are below their respective arrows. Requiring both series to turn in order to generate a signal may delay some of the signals but it also avoids whipsaws, such as those in the three blue ellipses. This is not a perfect approach but does give us a good objective view of when commodities are in a primary bull or bear market. At present the sell signal, which was triggered last year is still in force, so I am assuming that the bear market is intact. If that assumption is correct then prices should act as if they are in a bear market. From a practical point of view that means that the likelihood of false breakouts developing are greatly enhanced. Also, that prices are very sensitive to overbought conditions and are likely to reverse to the downside when they are approached.

Chart 12

In that respect Charts 13 and 14 hint that the 2015 commodity rally could well be over. For example, the DB Commodity ETF, the DBC, experienced a false break above the green trendline. That whipsaw took place under the context of a doji shooting star and would be confirmed with a violation of the red up trendline.

Another test of a bear market comes from the sensitivity of the price to an overbought reading. If it’s a bear market then we would expect the price to retreat close to achieving that overbought condition. Chart 14 shows that during the bear market environment that has existed since 2012 every time the CRB Composite 25-day ROC has reversed from its overbought line prices have fallen. This week it reached the line again, so we will see whether this characteristic is still in force. I would expect to see prices retreat but if they do not that will be a sign that perhaps a bull market of giant trading range has given way to the bear.

Chart 13

Chart 14

Good luck and good charting,
Martin Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.