Are EM stocks flashing a 'sell' signal?

The US-China trade war is reconfiguring the global supply chain, depressing risk sentiment, and providing a significant headwind to emerging market equities. The latest Asian export data indicate that an overall regional slowdown is indeed in place, and it could be growing worse. Investors are now looking to Beijing for new stimulus measures, but it remains unclear just how far Chinese authorities are willing to go.

The longtime, unofficial USDNCH cap at 7.00 is one element that markets are now watching for signs of breakdown. China’s May 15 decision to apply an RRR discount to small- and medium-sized received only the most tepid response.

Collateral damage in EM

Risk aversion and Chinese weakness point to a likely decline in emerging market equity prices. On Monday, Saxo Bank Head of Equity Strategy Peter Garnry outlined his thoughts on how the “new Cold War” developing between the US and China represents a sell signal for EM stocks. Garnry states:

“Emerging markets have declined almost 10% in just four weeks and we expect this trend to grow much worse given the current trajectory of the US-China trade headlines. Our tactical asset allocation view is to be underweight emerging markets. It also seems that the market is the least complacent on direct and indirect exposures to China, so the best way to express negative views on trade is via emerging market equities, KRW, JPY, oil, Australian equities and bunds.”

A technical view

We are looking at the EM equities complex via the iShares MSCI Emerging Markets Index (EEM:arcx), where this month has seen investors offloading investments from EM at the fastest rate since last year’s Turkish and Argentinian crises. 

“The iShares MSCI Emerging Markets Index Fund has fallen by 12% since its April peak compared to under 6% for the S&P 500,” says Saxo technical analyst Kim Cramer Larsson. 

“Investors are moving out of higher-risk assets”.

With EEM now below the previous support area at 41.50, Larsson now sees the ETF closing the breakaway gap from January. “This means no strong support before the December 2018 low around 38,” he adds.

The relative Strength Index is in bearish territory with minor divergence, indicating that the selling pressure is weakening.