December 14, 2009

Emerging Versus Domestic Equity Markets

Markets continue to rise, albeit with fading breadth – is the ongoing rally for real, or is something larger at play?

The above weekly charts plot the percentage change in price using two alternative top / bottom views. On the left, the SPY top / bottom from Oct 07 / Mar 09 respectively are used as the calculation basis; on the right, the ILF top / bottom from May 08 / Oct 08 respectively serve as the calculation basis. The markets used are:

• SPY – SPDR S&P 500 ETF, black bars
• ILF – iShares S&P Latin America 40 Index, fuchsia line on close
• EEM – iShares MSCI Emerging Markets Index, red line on close
• EFA – iShares MSCI EAFE Index Fund, olive line on close
• EWJ – iShares MSCI Japan Index, orange line on close

One of the primary differences between the two plots is the time between top and bottom. The Latin American market, which continued to climb for some 7 months into May 08 following the S&P 500 top in Oct 07; while the S&P continued to sell off into Mar 09, the Latin American market bottomed earlier in Oct 08. That time delta is significant, and offers a window into the current state of the US domestic rally – this is, perhaps, a beta play on riskier emerging market assets.

Case in point, using both the S&P top / bottom, the US domestic significantly lags the Latin American market. Moreover, it lags the Emerging Markets as well. Both represent riskier investments in the eyes of most, so the rally takes on a new light. Reviewing the same markets using the Latin American ETF top / bottom, markets have recovered nearly the same value dating back to their respective May 08 value. Taken from Oct 08 prices, however, the domestic again lags the Latin American and Emerging Markets even more. Optimistically, this may intimate the US Domestic sell off was an overshoot to the downside; taken from an another point of view, money has flowed more heavily into riskier assets overseas. Much of the US Domestic market recovery was represented by flows into deep value names, supporting the latter observation regarding investor sentiment.

Unspoken is the breakdown in Japan. Fall 08 has proven to be a down period for the Japanese market. This move was forewarned in a previous piece when the market, then priced in Gold, had broken an important trend line. Though the European and US Domestic markets have traded higher, albeit a possible beta play against the more volatile Latin American and Emerging Markets, the Japanese market has faultered. Technicians should continue to look at sectore rotation and the relative strength between markets of interest priced in Gold in the weeks ahead for clues going into 2010. For example, a quick review of the US Domestic sector rotation model shows a continued move into Health Care accompanied by a strong move into Utilities – a truly defensive signal.

Jeffery E. Lay, CMT
President
Talon Eight, LLC

Disclaimer: This post is intended solely to disseminate information, and is not, and shall not be construed to constitute financial, investment or other similar advice. All posted material should be independently verified for accuracy and current applicability. Readers of this post are referred to the Risk Disclosure for further information.

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