Emerging Markets in a Historic Panic

There’s no other way to describe what’s currently happening in Emerging Markets.

To get everyone up to speed, I will start this post with some charts I shared on Twitter over the last week, and then share some new charts (never seen before), tying everything together at the end and making the case for a major potential opportunity in EM.

In chronological order:

On August 6, 61% of Stocks in the South Korea KOSPI Index hit oversold RSIs. Only two other times in history were more oversold: (1) The four trading days from October 24-29 2008 which included the KOSPI’s exact final bottom of the Bear market (October 27). (2) The only other day, October 29 2018, was the exact day the KOSPI bottomed last year. So far, August 6 was the exact day of the bottom in KOSPI for this year.

Also on August 6, 47.23% of Stocks in the South Korea KOSPI Index made new 52-Week Lows. I shared the below chart on Twitter with the following comments: in nearly 20 years, just ten days had more than 45% of Korean stocks at 52-Week Lows. August 6 was the 9th most oversold day in data history. The most recent spike (2018) led to an +18% rally. The other spikes (2003, 2008, 2011) led to career-making rallies.

On August 13 and 14, a historic 76% of Stocks in the Hong Kong HSI Index (H-Shares) hit oversold RSIs. This was one of the most negative extremes ever. Incredibly, H-Shares were nearly as oversold as their 2008 lows. Including last week, in the last 18 years just seven total days had more than 75% of H-Shares with Oversold RSIs. Last Tuesday and Wednesday were the #5 and #6 most oversold days in history. After those spikes, a common pattern was for the market to spend some weeks forming a base, eventually transitioning to a multi-month rally. So far, August 14 was the closing low in the H-Shares index.

Now let’s look at some NEW charts that I researched and saved specifically for this report today:

My Emerging Markets Intermediate Breadth Oscillator is extremely compressed. Similar to the prior charts, this indicator shows the net amount of EM Stocks declining has reached nearly historic oversold levels. In most prior cases, this created a “ball held underwater” situation where EM Stocks ultimately responded with an extremely sharp rally. In some cases, a historic rally.

EEM ETF. Here too, we are witnessing history being made. This is the most liquid, most popular EM ETF in the world. And its NAV discount has reached one of biggest extremes of all time, indicating EM traders want to “sell at any price”. This panic condition has produced some of the biggest bottoms in history, including the exact 2008 low, which was just barely more extreme than today.

My EM Core Trend Model is at major oversold Buy levels, already below the region where all EM bottoms formed since 2009. It’s important to mention that risk remains elevated while the model is still declining. Still, I’m looking for a turn up in the model to provide a clue that an important bottom has been made. The oversold conditions are so broad and historic, it’s possible that EM (particularly H-Shares and KOSPI) are bottoming before U.S. Markets. Hold that thought for now and I’ll talk more about this later.

As would be expected from a panic of this magnitude, the outflows have also been proportionally historic:

EEM Net Flows. Widespread selling should lay the groundwork for a bigger recovery later this year, as funds are forced to chase the recovery. Any residual price declines from here would likely make the capitulation even more extreme.

EWH Net Flows. Massive & historic outflows, second largest on record. Since this ETF’s inception 23+ years ago, the record outflow was back in 2013 during the Chinese bank liquidity crisis, when overnight SHIBOR spiked. Social mood and panic may be approaching similar proportions.

MCHI Net Flows. Biggest panic on record.

IEMG Net Flows. First outflows ever.

Next is a chart overlay of the H-Shares Index with USDHKD Risk Reversals. This shows that a wave of China Bear tourists are betting heavily against the Hong Kong Dollar in the currency options market, highlighted by the extreme and historic spike in Risk Reversal pricing. Historically, similar panics led to major bottoms in H-Shares and huge recovery rallies. I originally shared this chart on Twitter on August 14, with the following added comments: “Hong Kong’s leadership warned last week the city risked sliding into an “abyss”. With social mood and markets in mass capitulation, the bar for a recovery is very low.”

Finally, let’s take a look at two critical price charts I am watching.

HSI weekly chart held the nine-year horizontal shelf and the 200wma, closing last week with a potential Bullish hammer.

Last but not least, note how the EEM chart is potentially tracking for a bottoming scenario. I’ve been updating this scenario in real-time on Twitter over the last few weeks. Note the potential wedge structure in play – which could be missing a final mini-flush lower followed by Bullish reversal. It doesn’t have to play out exactly like this, but overall I think the message is that EM and particularly Asia Equities are close to a turn (and may have already bottomed for the most part).

IN SUMMARY,

Emerging Markets are in a historic panic — particularly Asian Equities which represent the bulk of Global EM market cap.

A major cluster of signals is coming together at this critical time, with the potential to form a historic bottom.

Additionally, since EM has been completely wiped out, it could be bottoming before U.S. Stocks. This happened many times throughout history. (*most famously, in 2001-2002 and 2008-2009). It also happened most recently in December 2018, when EEM made higher lows and continued to form a base while the S&P plunged another -16% in three weeks. I think any residual lows in U.S. markets over the next few weeks would help draw well-developed sideways/basing structures in EEM, EWH, EWY and FXI — setting up a Major Global Equity rally later this year. I believe this theme is so critical to monitor, I will dedicate the next several weeks to track and share everything I’m seeing here and on Twitter — so stay tuned.

Thanks for reading.

If you liked this post, please share it with colleagues, subscribe to the Blog to receive future updates, and follow me on Twitter for daily charts: @MacroCharts.