EMERGING MARKETS : MORE PAIN COMING / BARRON´S MAGAZINE

Getting Technical

MONDAY, JUNE 24, 2013

Emerging Markets: More Pain Coming

By MICHAEL KAHN

Stocks, bonds and currencies in emerging markets have plummeted in recent weeks, and the charts suggest they have farther to fall.

In technical analysis, there always is a balance to be struck between short-term and long-term conditions. Emerging markets, for example, look ripe for quick snap-back rallies, but investors should leave them to the pros. This camel's back is broken.

Earlier this month, I wrote here that emerging-markets weakness was signaling something bad for global markets (see Getting Technical, "Emerging Markets Send Worrisome Signal," June 10). With the Dow Jones Industrial Average down more than 600 points since then – most of that coming within the past four days – the emerging-markets signal was indeed accurate.

And even thought the iShares MSCI Emerging Markets Index Fund (ticker: EEM) is down nearly 10% over that span and 18% since early May, this is no time to jump back in. Support remains roughly 4% below Monday's trading, and given the speed of the decline there's a strong possibility of an emotion-driven penetration of that level (see Chart 1).

Chart 1

Emerging Markets ETF

One look at the chart shows this support level to be the bottom of a multiyear-trading range. That means that in four years, the ETF tracking the supposed engine of global growth has gone nowhere.

While we must give support – the bottom of a trading range – the benefit of the doubt, it is very hard to imagine that emerging markets will hit it and suddenly find a long-term floor. A short-term bounce suitable for short-term trading seems to be more in line.

In China, the Shanghai Composite index shed more than 4% last week as short-term interest rates spiked higher. In contrast, the Dow fell by about 1.8%. Then, early Monday, the world got the news that China may not act to prevent a liquidity crisis there and that sent stocks tumbling 5.3% on the day.

While investors can track movements of Chinese stocks via the iShares Trust FTSE China 25 Index Fund (FXI), it does not tell the real story about the trend. The Shanghai Composite itself has not only erased its entire rally from last December's low, but it is on track to trade at its lowest levels since January 2009 (see Chart 2).

Chart 2

Shanghai Composite

Chinese stocks bottomed in October 2008, five months ahead of the Dow, and now prices are not much higher than they were at the end of the 2007-2008 bear market. The cynical question is "what bull market?" Indeed, the economy that was hailed as the new powerhouse has seen its stock market in decline for more than four years.

The term "dead-cat bounce," which comes from the Wall Street saw that "even a dead cat will bounce when dropped from a high enough level" may apply here. A one-month 15% decline can bring out the bottom fishers, and technical momentum indicators do suggest that the market is oversold. But with the trend so solid to the downside there is no reason for investors to speculate – at least not until the short-term trend stops falling.

Emerging-markets bonds are not faring any better than stocks. As the benchmark 10-year U.S. Treasury yield jumped higher, prices of bonds of every stripe have gone down in price: Treasuries, junk and municipals. The iShares JPMorgan USD Emerging Markets Bond Fund (EMB) is no exception: It is down 15% since early May, with half of the losses coming in the past four days (see Chart 3).

Chart 3

Emerging Markets Bond ETF

The rising trend from the 2008 financial crisis lows was obliterated on the decline. Such technical damage requires a good deal of time to repair, and as with stocks, this market may experience a "dead-cat bounce."

But the trend is now down and that means investors would be fighting it if they think emerging-markets bonds are cheap. Cheap can get cheaper.

I wrote last week about plunging emerging-markets currencies, such as the Brazilian Real and Indian Rupee. Although too thinly traded for most investors to buy and sell, the WisdomTree Emerging Currency Fund (CEW), a basket of many emerging currencies from across the globe, shows the carnage happening in this marketplace (see Chart 4).

Chart 4

Emerging Markets Currency ETF

Timothy Kelly, Editor-in-Chief of ForexTV.com, says emerging-market currencies are getting hit over concerns about global growth. He sees the trend continuing through the summer.

On the charts, the plunge last week followed a month of steep declines and looked eerily similar to the stock market after the crash of 1987. If there is any similarity in the two markets and the sentiment behind their respective moves then we can expect volatility, not rebounding prices, to rule for many weeks to come.

While upside corrections – "dead-cat" or otherwise – are always possible, emerging-markets stocks, bonds, and currencies have all seen significant technical damage. Investors should avoid them until they stabilize and prove that the worst is over.

Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.
           

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