Apr. 9 2011 – 5:00 pm | 479 views | 0 recommendations | 0 comments

By TOM ASPRAY

Technical and fundamental signals are indicating that emerging markets may soon regain leadership. Here are four emerging markets ETFs with the best risk/reward profiles along with suitable entry points and stop levels for each.

For the first time this year, it seems as though investors are once again warming to emerging markets, and if you take a look at the charts for emerging markets ETFs, this will not be a surprise. The latest data from EPFR Global shows that in the week ending March 30, there was a net inflow to the emerging markets of $2.6 billion, almost offsetting the $2.7 billion that went out the prior week.

The net outflows so far this year of around $26 billion are in sharp contrast to the $90 billion that went into the emerging markets last year. One week in January 2011, there was a $7 billion outflow that corresponded nicely with the lows in some of the markets.

On the institutional side, there are no signs of a renewed interest in the emerging markets. Many of the emerging markets have accelerated to the upside in the past few weeks, but it is the changing relationship of an emerging market benchmark to the S&P 500 that suggests they may outperform the US market for some time.

There are obviously some fundamental factors that have improved the outlook for the emerging markets, as several countries have seen inflation rates stabilize and their higher relative interest rates makes the currencies more attractive on a yield basis. A weaker dollar is also usually a positive for the emerging markets.

Figure 1

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The weekly chart of iShares MSCI Emerging Market Index (EEM) shows a long-term uptrend, line b, which was broken briefly in March when all global equity markets plunged, however, EEM held above it on a closing basis. As the red dashed line indicates, the decline held above the April 2010 highs as this former resistance became support.

EEM has accelerated to the upside and is already reaching the weekly starc+ band, suggesting that now is a high-risk time to buy because typically, prices are likely to consolidate or correct before substantial new highs are made.

(See Buy, Sell, or Wait: A Way to Decide for more on trading with starc bands.)

The weekly on-balance volume (OBV) also briefly violated its major uptrend (line e) in March, but the OBV has turned up and is likely to close above its weighted moving average (WMA) this week. The OBV did confirm the late-2010 highs, which is positive for the intermediate-term trend.

EEM has initial Fibonacci targets at $52 with the upper parallel resistance (line a) in the $60 area. This is also the equality (100%) target if the rally from the 2010 lows is equal to the rally from the March 2009 low to the December 2009 high.

The long-term chart for EEM reveals some interesting relationships to the S&P 500 that are quite relevant to the current market action. On the chart, you will note that EEM declined very sharply from the May 2008 highs, making its bear market lows at $18.22 in late-November 2008.

After rebounding into early 2009, EEM made a secondary low at $19.86 during the week of March 7. This was well above the previous low, while in contrast, the S&P 500 made significant new lows in March 2009 before bottoming out. This divergence suggested that in March 2009, the emerging markets should continue to perform better.

Both markets rallied for the rest of the year, though EEM had outperformed the Spyder Trust (SPY) by over 20% at year end.

EEM declined more sharply than SPY in early 2010 and continued to be weaker as both peaked in April 2010. The April high for the cash S&P 500 was at 1217.50, which was 6% above the late-2009 highs of 1148. In contrast, EEM peaked two weeks earlier than the S&P 500 in April and its high at $44.02 was only 2% above its earlier high.

Figure 2

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As I started studying this relationship, I wanted to take it a step further by putting together a relative performance, or RS chart, of EEM versus the SPY. On December 10, 2008 (not shown), a five-month downtrend in the RS was broken, and by April 2009, when the chart begins, the RS had turned up sharply. From the April and August 2009 lows, I have drawn an uptrend, line A, that held until it was broken on December 23, 2009 (line 1). This RS uptrend indicated better relative performance of EEM during this period, and it did outperform SPY by over 22%.

As EEM was making new highs in early 2010, the RS line was forming lower highs, suggesting that it had given up its leadership. Over the next few months, a downtrend (line B) was established.

Up to the April 2010 highs, SPY gained about 3% more than EEM. On June 23, 2010 (line 2), the downtrend, line B, was broken. As the RS continued to move higher, a new uptrend was formed (line C) as the RS made a series of higher highs and higher lows.

In October 2010, the RS once again failed to make new highs with EEM, and on November 12, 2010 (line 3), EEM violated its uptrend, line C. During this period, EEM outperformed SPY by over 8%.

The RS had been in a downtrend since last November (line D), but it was broken on March 22 (line 4). During this period, SPY gained over 8% while EEM was essentially flat. In the short period since March 22, EEM is up 8.7% versus just 2.7% for SPY.

Over the past few years, the periods when EEM has outperformed SPY have typically lasted from six to 12 months. Therefore, there should be plenty of time to profit from the emerging markets’ superior relative performance. Here are several ETFs which, in my opinion, have the strongest charts and best technical readings while also offering favorable risk/reward profiles.

A High-Yielding Emerging Markets ETF

 Figure 3

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The WisdomTree Emerging Markets Equity Income Fund (DEM) “Seeks investment results that correspond to the price and yield performance, before fees and expenses, of the WisdomTree Emerging Markets Equity Income Index.” The largest holdings in DEM are in Brazilian and Taiwanese companies, followed by Turkey and South Africa. Recently, over 20% of the holdings were in the telecommunications and financial sectors.

The weekly chart shows the rally from the recent lows at $55.74 to a high Tuesday of $62.74, which is pretty astounding while DEM also yields around 3.7%. The weekly chart shows an impressive breakout last week above long-term resistance at $60.30, line a. This is quite significant, since anyone who bought DEM since the start of 2008 did so at lower levels, and therefore, there is little overhead supply.

The recent trading range has upside targets in the $65-$66 area. The equality target, using the rally from the March 2009 to the April 2010 highs and measuring up from the May 2010 lows is at $70.

There is initial support in the $61 area with further in the $59-$60 area. The 20 week period exponential moving average (EMA) is at $57.59 with further chart support now in the $55.70 area, line c. The long term uptrend in the $54 area. The weekly OBV completed a major bottom formation in September by overcoming the resistance at line e. The OBV has turned up but is still below the previous highs.

How to Profit: Given the yield component, this ETF looks quite attractive, but nevertheless, it should only make up a small portion of your portfolio. I would recommend going 50% long at $60.68 and 50% at $59.72 or better with a stop at $57.27 (risk of approx. of 4.3%) Sell half the position at $64.82 and raise the stop on any remaining position to breakeven.