We Are Starting To See Increasing Relative Strength In Emerging Market ETFs (EPHE, EEM, EWW, EWH)
Following through on last Friday’s weak closing price action, the broad market gapped lower on yesterday’s open. However, stocks quickly stabilized and traded in a choppy, sideways range throughout the first half of the day. Buyers stepped into the market in the final two hours of trading, enabling the major indices to move to new intraday highs and trim their closing losses. Both the S&P 500 Index ($SPX) and Dow Jones Industrial Average ($DJIA) settled 0.2% lower, while the Nasdaq Composite ($COMPQ) lost 0.6%. The small-cap Russell 2000 Index ($RUT) and S&P MidCap 400 Index ($MID) slipped 0.4% and 0.2% respectively. All the main stock market indexes closed in the upper third of their intraday highs.
Volume fell substantially across the board, which was not surprising given that the previous day’s session was quarterly “quadruple witching” options expiration day. Turnover in the NYSE eased 35%, as total volume in the Nasdaq receded 27% below the prior day’s level. Even factoring out last Friday’s volume spike that was due to options expiration, trade in the NYSE was still below its 50-day average level. Nasdaq volume was only fractionally higher than average. Therefore, it’s safe to say that yesterday was not a “distribution day,” which would’ve been indicative of institutional selling. As for market internals, declining volume exceeded advancing volume in the Nasdaq by a margin of just over 3 to 1, but the NYSE ADV/DEC volume ratio was only negative by a ratio of just over 3 to 2.
One not so obvious situation we observed in yesterday session was the relative strength in international ETFs. In the September 21 issue of The Wagner Daily and on this blog post, we discussed that international ETFs, particularly those of emerging markets, were starting to show signs of bullish price momentum. That initial observation is now being manifested by the fact that all the ETFs we discussed that day managed to close slightly higher in yesterday’s session, despite the losses in the S&P 500 and Nasdaq. The iShares Philippines Index (NYSEARCA:EPHE), which we bought in our model ETF trading portfolio on September 21, gained 0.8% yesterday. The other international ETF we bought the same day, iShares Emerging Markets (NYSEARCA:EEM), managed to eke out a gain of 0.1%. The iShares Hong Kong Index (NYSEARCA:EWH) and iShares Mexico Index (NYSEARCA:EWW), both of which have also been on our radar screen over the past several days, rose 0.3% and 0.2% respectively.
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The increasing relative strength we are starting to see in emerging markets ETFs is positive not only for our open positions, but as a sign for the overall health of the broad market as well. If money is rotating into these ETFs, we view it as an indication of increasing appetite for risk amongst market participants, just as relative strength in the small-cap stocks is typically a positive sign for the broad market. In case you missed our initial entries into EPHE and EEM last Friday, either ETF could be bought near yesterday’s closing prices, as both ETFs are still trading within only about ten cents of our initial entry prices. We also like the current pattern in EWW, which is shown on the daily chart below:
EWW, which is trading near its all-time high, has gently pulled back from its “swing high” of September 14, and is holding above new horizontal price support of its prior breakout level, as well as its 20-day exponential moving average. The ETF also formed a bullish reversal candle yesterday by gapping lower on the open, then reversing to close positive and near its intraday high. With this pattern, EWW could be considered for buy entry just above yesterday’s high, with a stop below the 20-day exponential moving average. This would provide one with a positive reward to risk ratio on the trade. However, because we already have exposure to two different international ETFs in our model ETF portfolio, we are not listing EWW as an “official” trade setup in today’s newsletter.
India ETFs. Reforms. Really?
Much has been made of the “burst of reforms” unleashed by Finance Minister Chidambaram in recent weeks. The stock market has rallied and animal spirits it seems are back. Everybody’s babbling about how the UPA, after eight years in power, has found religion ie “reforms”.
The market is now at 21 times price to earnings (trailing twelve month free float adjusted as per the National Stock Exchange). Once more the mood swings violently. More interestingly the India VIX , the fear index is at 3 year lows of 15. This is usually an indicator of complacency, and historically such lows have signified a massive sell off. The combination of the stretched price to earnings and the VIX means the market is ripe for a big sell off. My two bit as an Ivy educated fund manager in Bombay who has worked internationally on some of the world’s major structural adjustment and economic reform programs.
In reality, the reforms amount to bureaucratic tinkerings with percentages – of a sort that only tax mavens and accountants can comprehend. Witholding taxes go down by a percentage point or two. FII margin percentages change. Service tax percentages for insurance companies change. Now an attempt’s been made to increase the percentages foreigners can hold in insurance and pensions. (This last will never pass through Parliament given the unanimous opposition to it). Blah Blah Blah.
The Indian economy, in fact, requires Parashurama’s ax and not the surgeon’s scalpel. The reference is to the mythical woodcutter of Indian mythology who wields a massive axe when needed. Wholesale violence will have to be committed on large areas of India’s economy with Parashurama’s axe, if we are to resume a decent growth rate.
The government had no choice but to unleash this wave of tinkering and call it “reform”. It is trying to keep the capital markets buoyant because it needs to sell or “chipkao” (i.e. stick, as we say in the business) close to Rs 40,000 crores worth of equity. This with spectrum auctions, hopefully plug the budget deficit a little by March. More crucially, it will also free up resources for massive election giveaways in next March’s budget. This is especially needed if the Food Security Bill –Madame Sonia’s chosen strategy for reelection – is to be passed.
Real reforms for India will not happen for a long time. These include financial sector reform, and an end to the financial repression signified by the statutory liquidity ratio. Privatization of the banking system that’s put an end to the ridiculous spectacle of 75 % of the banking system being owned by the government in a market economy. Bankruptcy and exit laws will have to be introduced. Labour market liberalization and the freedom to hire and fire labour will have to be allowed.
The collapsed state of Indian cities will have to be addressed by building 30 to 40 cities to accommodate massive rural urban migration. Land acquisition which is impossible now will have to be addressed. This list does not even include the sector changes required in real estate and infrastructure and sugar, and so on and so on. None of this is happening ever, it seems.
Everybody’s babbling in the media about how crucial the February budget is going to be for the UPA because it will be packed with big ticket sops like the Food Security Bill. Remember game theory however. It is crucial to take your opponent’s reaction into account. The Opposition also knows that the budget will be crucial to the UPA’s reelection chances ! Why then will they allow the UPA to present the budget at all. Especially when they have the numbers and the government is already on life support and in a minority. !!!
The government therefore, will, in all likelihood, fall in November-December, during the winter session of Parliament. Elections will take place in March-April as India needs the school system for a general election. This will allow the Opposition the chance to deny the government’s attempt to pass a budget full of sops and giveaways. The February budget will consequently be a vote on account. This scenario will suit all parties except the Congress and hence it will happen.
Is the market discounting the possibility that in a few weeks, all these guys PC etc. etc. will be gone ? Looking at the way its going up, I think not.
The logical conclusion also is that this is the high point of the markets move this year. India has gone from having the most incompetent FM (Pranab) to the most cunning FM (Chidambaram). The later is deliberately doing all he can to talk up markets to implement his plan. There is little need to oblige him and his plans of using the stock market as a financing vehicle, by buying high and losing one’s hard earned capital.