Life has been miserable for assets inversely correlated to the U.S. dollar, as they have faced serious headwinds over the past 12 months or so as the dollar surged. Particularly hard-hit were some emerging markets stocks, including those in the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM), which year-to-date remains lower by about 15% despite a relief bounce since late August.
Considering that the U.S. dollar still looks to be well-bid, the EEM ETF could fall significantly lower. That sets up for a trade for active investors.
All else being equal, when the dollar rallies, commodities priced in dollars will tend to fall so as to keep their same relative value. Commodity-heavy emerging markets thus also re-price lower, which is at least in part what we see reflected in iShares’ emerging markets ETF.
EEM ETF Charts
To show this relationship a little clearer, on the below chart I plotted the EEM ETFin the top half and the PowerShares DB US Dollar Index Bullish (NYSEARCA:UUP) in the lower half. The inverse correlation should be quite notable.
Furthermore, note that the dollar index since March has consolidated in a bullish wedge, which has the potential to resolve higher and would likely put further pressure on the EEM ETF.
Looking at the multiyear weekly chart of the EEM ETF we see that after forming a series of lower highs over the past few years, all of which put much pressure on horizontal support around the $35-$36 area. This support finally broke in August and now looks to be acting as resistance, as indicated by the blue bubble.
What makes this trade interesting, however, is not just the chart (which remains decidedly bearish for now), but the very global macro nature of this trade.
Large institutional investors are playing this trade, as opposed to fast-money traders playing in smaller stocks. From a risk management perspective, then, this means that the EEM likely won’t move very sporadically, but should have more orderly and cleaner price action to follow.
Finally, last Thursday following the FOMC interest rate announcement, the EEM ETF left behind on the daily chart a bearish reversal candle right at the yellow 50-day simple moving average. On Tuesday, the ETF dropped another 1.9% and broke below its support line from August, which meant the stock fell out of the rising wedge pattern marked on the chart.
From here, active investors could look to play the EEM ETF from the short side with a next downside target closer to the $30 area.
Any sharp bullish reversal should be respected as a possible trigger to stop out of the trade.
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Successful trading and investing starts with a plan. Download Serge’s essential trading plan, The Essence of Swing Trading e-book. As of this writing, he did not hold a position in any of the aforementioned securities.
