Emerging markets have rocketed higher since Donald Trump's election in 2016, with many benchmarks gaining more than 50%. The U.S. dollar's steady decline has driven the upside, raising the relative value of the Chinese renminbi, Indian rupee and other emerging currencies. However, this week's mini crash may have been a game changer, marking the first stage of a long-term top for emerging markets and a bottom for the greenback.
U.S. equity traders play emerging markets through three popular instruments: the iShares MSCI Emerging Markets Index Fund ETF (EEM), Vanguard FTSE Emerging Markets ETF (VWO) and iShares Core MSCI Emerging Markets ETF (IEMG). EEM and VWO have turned south right at their 2011 highs, which mark long-term resistance. The newer IEMG is trading at an all-time high but did not come public until 2012, well after the group topped out. (See also: The Risks of Investing in Emerging Markets.)
The iShares MSCI Emerging Markets Index Fund ETF (EEM) sprung to life in 2003, just a few months after the net bubble bear market ended, and entered a historic uptrend driven by China's rapid economic expansion. The rally carved an impressive Elliott five-wave pattern into 2007, topping out at $55.83 and plunging during the 2008 economic collapse. A bounce into 2011 stalled at the .786 Fibonacci sell-off retracement level, yielding a secondary decline that eased into a broad symmetrical triangle pattern.
The fund broke down in 2015, hitting a six-year low at $27.61 in the first quarter of 2016, ahead of a strong bounce that reached broken triangle support in September. It then broke out, posting impressive gains into January 2018, when it reversed less than two points above the 2011 high. The decline into February has relinquished nearly five points, posting the highest volume since November 2016. Bulls will retain the edge in this scenario until 50-week exponential moving average (EMA) support at $45 breaks, with that event raising odds for a long-term top and downtrend. (For more, see: A Look at iShares Emerging Markets ETF.)
The Vanguard FTSE Emerging Markets ETF (VWO) came public in the mid-$20s in March 2005 and settled into a strong uptrend that continued into the 2007 top at $57.83. It sold off to an all-time low at $18.50 during the bear market and bounced into the new decade, also stalling in 2011 at the .786 Fibonacci sell-off retracement level. The fund broke down from a four-year triangle pattern in August 2015, dropping to a six-year low at $27.98 in January 2016.
The subsequent recovery wave stalled at resistance in the upper $30s in September 2016 and broke out into 2017, rallying strongly into January 2018 when it stalled just seven cents above the 2011 high. The fund dropped more than four points during the downturn and is trying to build support at the 50-day EMA. This price action could signal the early stages of a major top, with the 50-week EMA at $44 marking the dividing line between bull and bear power. (See also: With Emerging Market ETFs Rising, Remember the Differences.)
The iShares Core MSCI Emerging Markets ETF (IEMG) opened for business in the upper $40s in October 2012 and fell into a broad trading range, with support in the low $40s and resistance in the mid-$50s. It broke down in the second half of 2015, dropping to an all-time low at $33.91 at the same time that rival funds bottomed out in 2016. It bounced back to broken range support in September.
A secondary buying wave remounted that level in February 2017, generating a strong uptrend that posted an all-time high at $62.70 on Jan. 26. The fund sold off into February, dropping almost six points before bouncing at the 50-day EMA earlier this week. Traders should look for this uptick to stall near $60, where short sellers may reload positions, expecting the decline to cut through the 50-week EMA at $54 and set off more potent sell signals.
The Bottom Line
Emerging market funds turned sharply lower with other U.S. equities during the broad-based rout, with older instruments reversing at their 2011 highs, which also mark major harmonic resistance. This downturn could signal the first stage in long-term topping patterns that end the group's advance. (For additional reading, check out: Should You Invest In Emerging Markets?)
<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>