As Q1 2019 comes to a close, there is a lot of chatter about the S&P 500 topping and a looming recession sparked by a yield curve inversion. That’s great and all but there is plenty more to analyze out there than just one US based index. Investors have other important decisions to factor in, including global markets and their relationships. For example, is it time to be investing in Emerging Markets? Are they going to outperform the S&P 500 going forward? What about Developed Markets outside the US?
It’s clear that US Indices are in a messy range. While the Yield Curve is an interesting topic of discussion, taking a look at the GoogleTrends results we can see this dominated the news about 4 months ago as well.. Does it matter? We’ll find out eventually. In the meantime, investors should be aware of global yields in a collective downtrend. In a post from The Chart Report earlier this month, we looked at what they might be signaling for US yields.
There’s plenty of questions that we can ask ourselves but at the end of the day all that matters is following price action. If not, investors might be missing the big picture. What if the real opportunity cost is not in being long or short the S&P 500, but in not understanding the current relationship between it and foreign markets?
This chart comes from Tom Bruni, CMT and Technical Analyst at AllStarCharts. The S&P 500 has been building out a 7-month base relative to Develop Markets (excluding US and Canada). Along with a rising 40-week simple moving average, price action suggests a continued move higher in this ratio.
The S&P 500 vs. Emerging Markets are also at an interesting position building out a base with a rising 200-week simple moving average. The 6.6 – 6.7 range in this ratio has a lot of price memory. Is SPY/EEM going to roll-over after a false breakout attempt? Or is this a larger cup-and-handle at play? What does it say about the global risk-on environment if Emerging Markets are outperforming? Does that scenario only happen if the S&P 500 rolls over? Or can it happen with both continuing higher too?
Taking both charts above a step further, plotting EEM against EFA we can see Emerging Markets’ underperformance relative to Developed Markets (excluding US and Canada). SPY is outperforming EFA and has the opportunity to continue outperforming EEM, but between the two underperformers, EFA is the stronger option.
It’s important to know that in EFA Japan makes up 24% of the ETF and in EEM China makes up 32% of the ETF. So if we plot these two countries against each other we’ll likely have a clue as to where EEM/EFA is headed next. As we can see in the chart below, the Shanghai Composite looks to be at a great risk/reward position here. Following a false breakdown below the 2014 lows and a breakout above the June 2015 downtrend line, Shanghai has room to head higher which will only help EEM relative to EFA.
Building on these charts, Tom was on RealVision last week discussing a few pair trade opportunities he is seeing. A pair trade is a market-neutral strategy that looks to take advantage of the outperformance of one equity market versus another, leaving you with a net exposure of zero. Let’s take a look at what Tom had to say because these are definitely some interesting trades you will rarely see talked about on FinTwit.
First up is Japan vs. the S&P 500. Why? Japan is the weakest name within Developed Markets.
Following a three-year base that resolved lower, EWJ/SPY has consolidated for ~5-6 months during 2018 and is now resolving lower again. “So the trade is as long as we’re below that low of 0.197 in EWJ/SPY, we want to be short with a downside target of 0.163.”
Looking to Europe, Tom also likes Portugal as a well-defined short. Following the loss of March 2017 and November 2018 support, after retesting .03969 PGAL/SPY is resuming to the downside with a target of .03330. “So if you had to make a short bet on a European country, I think Portugal would be a good one.”
Looking elsewhere in Europe, a potential false-breakdown opportunity is brewing in Germany. Tom states “we are seeing momentum diverging and we’re extended from a long-term downtrend line, which suggests that if we get back above those 2003 lows, we could see some mean reversion to the upside.” The 2003 lows correspond to .100 in the EWG/SPY ratio with a target of .111.
So whether we’re looking for trading opportunities or interested in long-term portfolio allocation planning, all market participants (including US based investors) should be aware of global intermarket relationships. Thanks for reading!