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Emerging Markets Showing Signs of Life

Emerging Markets ETF

This is sort of a busy chart, but I think an important one that you need to see.

The chart shows the price action of the Emerging Markets Index exchange traded fund (Ticker: EEM) for the past six months.

The big price chart in the middle shows that the ETF has bounced off the 200 day moving average (always a point you like to buy stuff if you believe in the fundamentals of the investment) as you can see from the circle, as well as bounced off the bottom of the blue price channel. The price channel represents two standard deviations from the 20-day moving average, which generally shows a price move that is getting tired. If you look at the top section of the graph, you can see that this also happened at the same time the Relative Strength Indicator was bouncing along the bottom and has started to strengthen.

In the section of the graph with the black candle sticks, this is the same EEM graph, but without the trend lines. Instead, I’ve drawn in the channel so you can see what has been happening to its price. Its important to note that after bottoming at the 200-day moving average, it has now broken above the channel.

I’ve also annotated the Accumulation/Distribution Line for you showing that even during the price correction, the trend of money flowing into EEM was still positive. You can also see that the despite the price sell off, the Money Flow (CMF) indicator has stayed above the zero line.

I’ve also annotated the Stochastics indicator, showing where it has turned positive at the bottom of its range, and the MACD Indicator at the bottom showing that the histogram in the middle is trending up and looks like it might move on up into positive territory.

What all of this is telling me is that we have the potential for the Emerging Markets to lead us out of the current market correction.

The question that needs to be asked is why would the emerging markets bottom while our markets look like they are stumbling? The answer is simple – monetary policy.

If you look at Brazil and India and other countries that have been raising interest rates over the past year, they have deployed a sensible monetary policy decision to combat inflation and bring economic growth back to sustainable levels. At some point very soon, they will stop raising rates and let their economies chug along growing at 6% to 8% sustainable growth rates – rates that keep their employment growing but that do not generate harmful price increases.

Stock markets are anticipatory – they will bottom six to nine months ahead of actual changes in economies. So, it is quite possible that the emerging markets are telling us that they have their inflation under control and that their stock markets will begin to move higher based upon earnings growth from a sustainable GDP growth. The recent drop in commodity prices where the speculators were shaken from the markets seems to support this thesis that inflation will be brought under control and monetary tightening can stop.

This is probably a low risk time for us to commit some money to our various Emerging Markets investments (mutual funds, ETF’s and individual companies). As with any potential change in direction, something could derail it and cause it to move back to the 200-day moving average – or even move back into the downward sloping channel — a geopolitical crisis, further evidence of inflation, oil moving back above $110 per barrel — things like that.

As we take action, I’ll be back to the blog with details for you to follow. I think you can safely assume, though, that we will be reducing US and European positions but keeping cash levels at the roughly 7% level in client accounts.

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