It seems emerging markets missed the rebound memo.
As buyers stepped up late last week to defend the pivotal 1600 level in the S&P 500 index, causing a strong two-day bounce, the iShares Emerging Markets ETF (EEM) experienced no such good fortune. On the contrary, the basket of less-developed countries from Asia, South America and elsewhere continued its descent into the abyss.
Sadly for the EEM bulls, the ongoing liquidation reversed earlier attempts of the beleaguered ETF to turn higher in April. The recent breakdown of April’s double bottom places the EEM on particularly shaking ground.
The stark divergence between the strength in the U.S. and weakness in emerging markets has driven the EEM/SPX ratio to a new four-year low. 2013 has been a particularly painful year for the relative performance of emerging markets as the rate of descent of the ratio appears to have reached terminal velocity.
While U.S. markets may well continue rallying without the participation of emerging markets, history suggests such a divergence shouldn’t persist for long.
As shown in the lower pane of the second chart at right, the correlation between the SPX and EEM has remained in positive territory over most of the past three years. Either the weakness in EEM will eventually drag the SPX down with it, or the ongoing strength in the U.S. will finally convince EEM to join the bullish festivites.
Of course, not all sectors have been affected equally by the bears’ dominance of emerging markets. Commodity prices in general — and metals like steel and copper in particular — have matched the relative weakness of EEM. Since I highlighted the potential for a trend reversal in steel stocks last month, the Market Vectors Steel ETF (SLX) has thrown us a curve ball by falling back below support and utterly destroying the beautiful bottoming pattern that was in the making (not shown).
The weakness in commodity-related industries like steel has successfully stymied the S&P Metals and Mining ETF’s (XME) attempts to climb back out of the deep hole it’s fallen into. Since breaking a short-term uptrend line last week, the XME has fallen to a key short-term support level. What’s worse, its relative strength has dropped back down to the lower end of its two-month range and is threatening to decline to yet another multiyear low.
Traders looking for continued weakness in emerging markets to weigh on the metals and mining space could consider buying the XME September 38-33 put spread for around $2.10. The max risk is limited to the net debit paid. The max reward is limited to the distance between strikes minus the initial debit, or $2.90, and will be captured if XME sits below $33 by September expiration. If you’re looking for more confirmation before pulling the trigger, consider waiting for XME to break below the $36.50 support zone.
At the time of this writing Tyler Craig had no positions on any of the aforementioned securities.