Is It Time To Buy Emerging Markets? (EEM)

Emerging markets grew rapidly in the last decade, in historic building booms that erected modern cities out of farmland. Growth stalled during the 2008 economic collapse and resumed in 2009, finally peaking in 2011. Emerging market GDP has contracted in the last five years while investors wonder if the time has come to rebuild exposure for the next growth spurt.

An emerging market economy has characteristics of a developed economy, like the United States or Japan, but doesn't meet the strict accounting standards of more advanced nations. BRIC countries Brazil, Russia, India, and China, fit this definition but have made substantial progress in building developed economies.

Russia and Brazil entered recessions in 2015 while China and India's growth continue at a slower pace than in the last decade. A historic decline in the Shanghai Exchange in 2015 continued into 2016, raising fears that China's growth engine is finally petering out, denying first world companies substantial profit opportunities. That leaves India as one of the few rapid growth portals in the emerging market economies.

Gauging Future Prospects

Macro issues affecting growth in developed nations also impact emerging markets, but specific country themes make broad brush predictions less reliable. China and India have diverse economies that should underpin growth rates well into the next decade but Russian and Brazilian economies are closely levered to energy prices, which have collapsed since 2014. Smaller emerging nations, including Mexico, face similar challenges aligned with trends in energy and other natural resources, including iron and sugar.

Given their reliance on natural resources, these economies will face headwinds until crude oil and other commodity markets enter new uptrends, allowing them to build hard cash reserves. Central bank policies have also taken their toll, with the Russian Ruble and Brazilian Real exhibiting high volatility that impacts foreign exchange. Brazil has a unique problem, as one of the few nations infected by high inflation that's forced its central bank to raise interest rates repeatedly.

Historic Price Action

iShares MSCI Emerging Markets ETF 2003-2016

iShares MSCI Emerging Markets ETF (EEM) tracks a market capitalization weighted index that includes exposure to mid- and large-cap securities in China, Taiwan, India, Brazil, Russia and other emerging market economies. It's overweighted in Hong Kong and the financial sector but still offers a useful snapshot of market activity, making it worthwhile as a prognostic tool.

The fund came public near 12 in April 2003. It showed rapid growth for four years, finally peaking at an all-time high in November 2007. The subsequent decline gave up the majority of its historic value, with the November 2008 bottom aligned with the 78.6% Fibonacci retracement. Volatile whipsaws into March 2009 yielded a new uptrend that lasted two more years.

That rally ended at the 78.6% retracement of the prior downtrend, in perfect proportion to the prior swing. The 2011 peak corresponded with a slight reduction in China's GDP growth rate, presaging a contraction that's continued into 2016. The fund chopped sideways for four years after the top, carving a symmetrical triangle pattern, and broke down in August 2015. That decline has continued into the first quarter of 2016.

Given similar proportions of long-term price swings since the fund's 2003 inception, it makes sense to watch for the current decline to stall or end when it reaches the 78.6% retracement of the 2009 to 2011 uptrend. That level comes into play in the mid-20s, which is just 4-points below the fund's value in February 2016. This raises the odds for a bottom in the second or third quarter.

What To Watch

Tracking commodity markets should work well in gauging emerging market prospects in 2016 and 2017. Also, China's economic data will have an outsized effect on other emerging markets due to its enormous world influence. As a result, any uptick in its GDP growth rate could bring investors off the sidelines and into new long-term positions.

From the technical standpoint, watch EEM when the fund drops into the 78.6% retracement of the 2008-2011 uptrend near 25 because these harmonic levels have signaled major reversals in 2008 and 2011. That price is likely to be reached during a period of high stress in world markets that may include climactic selling pressure in the U.S., Japan, Europe, and China.

That buy signal may come at a tough time because emerging markets carry a higher risk than developed markets, warning investors to steer clear in periods of market stress. Higher prices tend to follow the strong market action in the U.S. and Europe, with investors seeking out new opportunities after they've allocated capital to local favorites. This suggests that emerging market won't recover until bull markets resume in first world economies.

The Bottom Line

Emerging markets peaked in 2011 after a long-term growth spurt brought many of these nations into the modern era. The majority of these countries are dependent on natural resources, delaying a long-term recovery until commodity markets end their historic downtrends.

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