Since the trade disputes started in January, emerging market indices have been getting hit pretty hard and haven’t gotten the bounce back rallies the more developed markets have seen. The selling stems from a stronger dollar and the concern that less trade will hamper the emerging economies.
The iShares MSCI Emerging Markets ETF (NYSE: EEM) has dropped from the $52 area in January to a low of $42.15 last week. The selloff has caused the 10-week RSI and weekly stochastic readings to reach their lowest levels since January 2016.
I read several articles and saw several interviews on Bloomberg this week where different analysts were speculating that the selloff in emerging markets have run their course. Looking at the weekly chart, I can say that a rally seems likely in the coming months. However, based on the current economic state and the monthly chart, I’m not convinced that the rally will be a major one.
The ongoing trade disputes around the world will certainly take a toll on emerging economies, just as they will the more developed economies. If the disputes aren’t resolved soon, I can’t see the emerging market indices rallying more than 15-20%. This is what we saw each year from 2011 through 2014. You can see on the chart below that the monthly stochastic readings would dip down below the 50 level and then have a little bounce in the previously mentioned range.
It was after the bear markets of 2000-2003, 2007-2009, and 2014-2016 that the monthly stochastics dipped all the way down to the 20 area that we saw the huge rallies of 90% or more.
To me, there is some upside potential in the EEM, but I’m not sure the downside risk is worth it. The dollar has been rallying for the past four or five months and it has caused the ETF to drop over 20%. The strength in the dollar is a result of rising interest rates here in the states and with the Fed almost guaranteeing two more rate hikes in 2018, I don’t know that the selloff if over yet. The one good thing is that the Fed has been pretty transparent about its rate policy intentions, so that certainly limits the possibility of surprise.
It is possible that with the Fed laying out its plan, the dollar will grind sideways for the rest of the year and that will give emerging country currencies a break. However, that doesn’t mean the dollar is going to weaken anytime soon.
The fundamentals in many of the emerging economies are in good shape, but that is assuming two factors—the trade disputes get worked out and the dollar slows down its climb. If either of those two things don’t happen, I can see the EEM falling another 20-25%.
I guess my bottom line is this—if the trade disputes get worked out, there is some considerable upside for emerging markets. If the dollar starts to trade in a range, this too could push emerging markets higher. If I bought the EEM today, I would put a pretty tight stop on it of 10% or less.
I would prefer to wait and see one of three things happen before investing my own money in the ETF. One, the monthly stochastic readings reach the 20 level. Two, the trade disputes get settled and that cloud is removed from emerging markets. Three, the dollar moves lower for a month or two or at the very least runs in to some resistance. Using the dollar index as a gauge, seeing it remain below the 95 level for a few months would be encouraging.