Emerging Markets Remain Relatively Submerged

Emerging markets as a whole just can't seem to get out of their own way. The MSCI Emerging Markets ETF (EEM) is down 6% YTD and has been underperforming the S&P 500 for years. What is the current outlook?

Ultimately I believe a view on emerging markets in isolation is not enough and instead should be framed emerging versus developed, or as more of an asset allocation decision. Should I be repositioning more funds out of developed (S&P 500) and into emerging markets (EEM), or vice versa?

I have found that over time the relative return of industrial metals versus a commodity index (CRB) does a very good job at leading the relative performance of the EEM vs. the S&P 500. The relationship makes sense since emerging markets tend to have a high sensitivity to global economic activity, and industrial metals tend to have a higher sensitivity to global economic activity than most other commodities.

Source: Stockcharts.com

The weekly chart above shows five signals (2 buys, 3 sells) since 1999, triggered by trend line breaks in the industrial metals vs. CRB relative return (lower inset). 

Note that a relative-return buy signal for EEM has yet to be triggered. Therefore, based on this one indicator, better to remain overweighted in developed (S&P 500) and underweighted in emerging.

Consumer Discretionary: Pain Has Been Wealth-Indifferent

A few weeks ago I asked the question, "Is the amazing run for consumer discretionary stocks coming to an end?" Based on the hourly chart below, the jury is still out on that question.

The XLY continued to decline into earlier this month, underperforming the S&P 500 as shown in the upper inset. Since February 3rd, the XLY has bottomed and risen by about 6%, however note the relative performance. Initially the ETF outperformed sharply when rallying off the low, and yet since last Thursday the relative return of the XLY has reversed course and trended downward. This trend is in stark contrast to the ascending absolute price trend, resulting in a bearish divergence. 

I would also point out that with many consumer discretionary/cyclical stocks, the relative pain suffered YTD has been income or wealth-indifferent. As shown below, several higher-end, luxury names have taken it on the chin just as badly as companies associated with middle- to lower-income consumers.

High-end, luxury stocks vs. S&P 500

Middle- to lower-income stocks vs. S&P 500

The January Barometer, Another Take

I know it's a bit past-due, but I wanted to offer another take on the so-called January Barometer ("as goes January, so goes the year"). Others have already weighed in on this subject, quite skeptically overall, and yet I'm not so sure that this skepticism is warranted.

From data in The Stock Trader's Almanac, I put together the following:

Since 1950, there have been 40 occasions when the S&P 500 has been up in January and 24 times when the S&P 500 has finished down in January. For the 40 years when January has been up, the S&P 500 finished the year higher 36 times and was down for the year in just three occasions (with one year finishing near exactly flat, excluded). For the 24 years when January has been down, the S&P 500 has finished those years higher in just 11 occasions, with 13 of the 24 years resulting in down years. The key column above is on the far right, "% UP," listing the percentage of up years. Overall, for the entire 1950-2013 period, the S&P 500 has been up in 47 years and down in 16 (again, excluding the one flat year) for a 73% up percentage. Compare this 73% base line figure to 90% up years for the S&P 500 when January has been up and just 46% up years for the S&P 500 when January has been down. Interesting.

The following is from Ned Davis Research:
  

In the period 1928-2012, there have been 54 up Januarys and 33 down. What has happened after these Januarys, for February-December, thus excluding any effect January may be having on results for the entire year? For up Januarys, the ensuing February-December period has returned 8.3% on average or a median return of 10.9% for a 78% up hit rate. Whereas for down Januarys, the February-December period returned just 2.8% on average and an anemic 2.3% median return for a 58% up hit rate or percentage.

Based on the data above, I wouldn't be so quick to dismiss the January Barometer. It appears there might be something to it.

Encouraging Signs

With regards to a market bottom, last Monday I wrote that for starters I'd like to see 1) the S&P 500 put together three consecutive up days off this low or one significant up day with a bar/candle range spanning 15-20+ points, and 2) the MACD to trigger a buy signal, i.e. for a bullish crossover to occur in the 12- and 26-day EMAs, also shown with a positive histogram. As of today, it appears both of these conditions have been met.

Source: Stockcharts.com

The S&P 500 chart above shows three consecutive up days (including two fairly wide bars) and the MACD histogram turning positive. Granted, I would prefer to see a more meaningful buy signal from the MACD, but it's moving in the right direction. It's also encouraging to see the RSI (upper inset) get back above 50.

The NYSE High-Low Index is rising off an oversold level:

Typically when this index first rises from such a low level, it suggests a bottom is near. However, given the compressed severity of this recent correction, it wouldn't be unusual for the market to pullback on the heels of this recovery rally. As further confirmation that a credible low has been established, look for the MACD of the NYSE High-Low Index to trigger a buy signal (positive histogram) -- which has yet to happen.

We're Still Not There Yet

Last Tuesday, I asked "are we there yet?" with regards to a market bottom. My answer then was no, not yet, and it remains my answer. 

What will it take to change my view? For starters, I want to see two things happen.

First, I'd like to see the S&P 500 put together three consecutive up days off this low or one significant up day with a bar/candle range spanning 15-20+ points. Obviously both conditions occurring would be even better. The orange boxes in the daily chart above identify past instances when either of the two conditions have occurred. With the market able to string together at least three straight days of gains and/or experience a big positive spike for the day, it goes a long way towards indicating that sentiment is shifting from fear and caution to more assured, risk-seeking behavior by investors. And as shown in the chart above, we're not there yet. That said it's encouraging to see the S&P 500 holding above the 100-day moving average (red line), which has served as sturdy support in the recent past.

The second thing I'd like to see occur is for the MACD to trigger a buy signal, i.e. for a bullish crossover to occur in the 12- and 26-day EMAs, also shown with a positive histogram. I always prefer to see a meaningful signal with the histogram getting beyond just barely turning positive, but again as shown in the chart above, such a bullish signal is quite a ways off from happening anytime soon.

Having commented on the near-term outlook for the market, I thought it would be appropriate to briefly review a much longer-term perspective.

The monthly chart above displays the S&P 500 going back to 1997. In short, the longer-term backdrop for the market remains solidly bullish. I would become very concerned about a secular decline if 1) the 6-month moving average (blue line) were to cross down through the 12-month moving average (red line), 2) the stochastic were to breach 50 to the downside (note blue boxes), and 3) the rate of unemployment (orange line) were to begin to trend higher (see previous blog post). All three of these conditions occurred in late 2000 and in late 2007 or at the start of 2008. None of the three conditions are in place currently. The 6-month MA remains 75 points above the 12-month MA, the stochastic is extended at 95 (!) and the unemployment rate continues to trend down at 6.7%.

Of course, these conditions could change in the near future, and understand that I track (much) more than three indicators or conditions. But the larger point remains: it would take months for these conditions to change and until that occurs, the long-term market outlook continues to look bullish.