Written by Jim Welsh
Macro Tides Weekly Technical Review – Special Update 30 August 2018
On August 21 I recommended a 50% position in the Emerging Market ETF EEM for a number of reasons. The Dollar was expected to pullback which would relieve some of the pressure on EM currencies and the valuation of EM is considerably cheaper than U.S stocks. EM is down almost 20% in 2018 while the S&P 500 is making new all time highs.
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As discussed in the August 27 Weekly Technical Review, a recent Fund Manager Survey (FMS) by Bank of America Merrill Lynch found the highest allocation to U.S. equities since January 2015 and US equities the number 1 allocation for the first time in five years.
The high level of allocation is in response to data showing the U.S. economy has been performing better than Europe, Japan, Great Britain, and other developed economies and the fact that the US market has been performing better. If the US slows in coming months as seems likely, it may lead Fund Managers to rotate out of the US into EM.
Volatility in EM currencies reached very high levels in mid August comparable to spikes in 2001 after China entered the World Trade Organization and 9/11, and during the Global Financial Crisis. If volatility calmed down as it has after prior spikes, the return of stability would remove an important risk and enable EM equity markets to rally.
Technically, EEM’s RSI was oversold on August 15 but posted a higher low than in late June, even though EEM’s price fell below the June low (red line). The last time a positive RSI divergence occurred was in November and December 2016 (green line on RSI). This was followed by a substantial rally after the Dollar peaked in January 2017. A rally to $44.50 or so seems likely. A rise above $45.00 would exceed the late July high and would break above the down trending upper blue trend line and black horizontal trend line. A rotation into EEM will only happen after EEM starts to perform better and starts to register on computer screens.
Click on either chart below for large image.
The Dollar has corrected a bit and that helped EEM to rally. However, the rally has been weaker than expected with EEM falling well short of its resistance of $45.00. The high this week was $44.16 and didn’t even test the blue down trend line connecting all the lower highs EEM has posted since February. The rally was so weak that EEM’s RSI was not able to exceed the bounce high in July.
Most of the reasons for the recommendation are still in place. Valuations are still attractive and sooner or later there will be a rotation out of US stocks into EM. However, in the short term valuations can always get more attractive if a reason to sell materializes. Wednesday night volatility in the EM currency market increased. The Argentina Peso plunged to a record low causing the central bank of Argentina increase short term rates from 45% to 60%.
The weakness in the Peso is particularly worrisome since Argentina has already secured a $50 billion dollar loan from the IMF. The Indian rupee also fell to a record low while the Indonesian rupiah hit a three year low and the Brazilian real hit a two year low. The Turkish lira rebounded after posting a record low in mid August, but fell 6.65% last night and it wouldn’t take much for it to make a new record low.
Federal Reserve Chairman Powell made it clear in his Jackson Hole speech on August 24 that the Fed is intent on its path of raising rates in coming months. The renewed weakness in these EM currencies since his speech suggests the potential for a EM currency crisis is rising, which means the risk of contagion is higher in coming weeks than it was on August 21. Based on these developments I’m recommending the position in EEM be sold. It is currently trading $42.95 (Wednesday close) which is just above the closing price of $42.92 on August 21.
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