Sunday, January 24, 2010

Emerging markets slipping below trend

The market’s date with a correction is approaching. Whether that correction amounts to a short-term setback or an expiry of bull market trend that started ten months ago, investor anxiety ratchets up with each down day recorded in global stock markets. This week’s drop in stock prices challenges the bullish price trends that have propelled global markets in the last two quarters, with emerging and European markets taking the biggest slap in the face. Many of the exchange traded funds representing these markets are in, or in danger of, turning Stock Trends Weak Bullish – a signal that should alert investors to re-evaluate their position.

Drops in the prices of a number of BRIC funds, including the SPDR BRIC 40 ETF (BIK-N), iShares MSCI BRIC ETF (BKF-N), Claymore BNY Mellon BRIC ETF (EEB-N) and the Toronto Stock Exchange-listed Claymore BRIC ETF (CBQ-T) are tripping trend alerts. All slipped over 5 per cent on the week by the end of Thursday’s trading, falling below the trend line support of the 13-week moving average. Funds invested in European countries also shared in that decline. Although Canadian equities dropped significantly this week with the materials sector, only gold stocks are currently in a Stock Trends Weak Bullish trend. This retreat in emerging markets, as well as resource equities, hardly arrives unexpectedly – but investors should be concerned about whether this is the beginning of a more serious correction. Is this time to take money off the table in global markets? Or is this a new opportunity to increase exposure to commodity and emerging market equities?

The monetary condition that has re-inflated these equity classes is plainly stated: negative real interest rates. Cheap money is always the source of asset bubbles, and the equity rally that ignited from the depths of a global recession owes a great deal to the immense amount of liquidity pumped into financial markets. However, eventually this excess must come to an end. Markets have spent the last few months trying to figure out when that time will come. A recent retreat in the price of gold, a tentative oil market, and the seeds of a relatively revived U.S. dollar are possible signals that a low short-term interest rate policy (oh heck, it’s a zero-interest rate policy in the U.S.) may end sooner than we think. If the punch bowl is taken away, commodity stocks and emerging markets will not rebound from the current weakness.

If U.S. interest rate changes are due, investors will be quickest to hit the sell button on emerging markets. The BRIC and Latin American funds that have dropped in recent sessions, in particular, deserve attention. The iShares MSCI Brazil ETF (EWZ-N), for instance, dropped to the $68 level this week, a mark it also fell to at the end of October when a chill hit the global reflation trade. Although a 15 per cent rebound from here would entice short-term commodity bulls, this Latin American fund, as well as others, are now below a supporting trend line – unlike the autumn retreat. A rally off this level is possible, but investors should be concerned about this trend line violation.

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