Foreign Stocks Face Key Tests (EFA, VWO, EEM)

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May 22, 2012 10:57am NYSE:EEM NYSE:EFA

Chris Ciovacco: Traders often look for relatively easy ways to monitor the battle between “risk-on” and ‘risk-off”. Given that foreign stock indexes have lagged the S&P 500 in recent months and the center of the risk universe sits in Europe,

you can make an argument the fate of the EAFE Index will determine the fate for the vast majority of risk assets. A partial list of the MSCI EAFE Index Fund’s (NYSEARCA:EFA) country weightings is shown below.

Tom DeMark, of Market Studies, LLC, has his own set of proprietary tools to determine and monitor key support levels. Last week, EFA closed below DeMark support levels on its daily, weekly, and monthly charts. The longer EFA remains below these levels, the more concerning it is for all risk assets in the short-to-intermediate term. Conversely, if EFA can recapture the levels shown below, it gives some hope for a risk rally.

On May 13, we described how to estimate possible downside “targets” when a market has a set-up for a head-and-shoulders pattern. A much longer-term, and potentially bearish, head-and-shoulders set-up appears to be forming on the weekly chart of EFA. The green lines show a possible downside target of 33.55, which represents a 27.5% decline from the pink neckline. The pattern becomes much more meaningful from a probabilistic perspective if price violates the pink neckline. For now, the pink line represents a possible area of support.

The weekly chart of the EAFE Index below shows possible levels where buyers may become interested (a.k.a. support). The most important levels relative to the head-and-shoulders pattern shown above are 45.90, 44.91, and 43.27. Each successive break of those levels would increase the probability of the head-and-shoulders pattern taking prices toward 33.55.

It is extremely important not to assume a bearish head-and-shoulders set-up will produce bearish outcomes. The term “set-up” hints at probabilities, not certainties. The S&P 500 Index had a head-and-shoulders set-up in early October 2011. The set-up did not produce bearish outcomes.

This article provides several key EFA levels to watch. With policymakers and central bankers waiting in the wings, it is best to monitor the levels with an open mind. A break of support becomes more meaningful if it can carry into week’s end. The violations of the DeMark support levels shown previously did carry into the end of a week, which means we need to respect that weakness could continue in global markets.

Related: iShares MSCI Emerging Markets Index (NYSEARCA:EEM), Vanguard MSCI Emerging Markets ETF (NYSEARCA:VWO).

Written By Chris Ciovacco From Ciovacco Capital Management, LLC

Chris Ciovacco began his investment career with Morgan Stanley in Atlanta in 1994. With a focus on global macro investing, Chris uses both fundamental and technical analysis to assist in managing risk while looking for growth opportunities around the globe in all asset classes. If you are looking for an independent money manager or financial advisor, Ciovacco Capital is worth a look. Chris graduated from Georgia Tech with Highest Honors earning a degree in Industrial and Systems Engineering in 1990. His experience in the professional ranks began in 1985 as he began working as a co-op for IBM in Atlanta.

Ciovacco Capital Management, LLC (CCM) is an independent money management firm serving clients nationwide. By utilizing extensive research, disciplined risk management techniques, and a globally diversified approach, CCM prudently manages investments for individuals and businessowners. Our focus is on principal protection and purchasing  power preservation in an ever-changing global investment climate.

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