Emerging Market ETF Shows No Divergence

The war against Iran has pulled down the major US indices, and it has hit some overseas markets even harder.  One encouraging sign, though, is that there is no bearish divergence apparent yet between EEM and the SP500.

EEM is the "emerging markets" ETF sponsored by iShares.  It supposedly invests in stocks in new markets that are just getting going, although its two largest holdings are Taiwan Semiconductor (TSMC) and Samsumg.  One could argue that both Taiwan and South Korea are already past the "emerging" stage.  TSMC alone accounts for a 13% weighting in the fund.

What I find interesting about EEM is that it pretty reliably shows us a bearish divergence versus the SP500 at important price tops.  It is not showing us one right now.  The chart above shows us that there were big divergences at each of what I would call the major price tops of the last 5 years.  And that includes just before the 2020 Covid Crash at the left end of the chart. 

Divergences are important, although one big problem is that they can persist for a long time before they finally decide to matter.  A divergence is "a condition, not a signal".  It will not tell us when it is going to matter.  And divergences can sometimes get "rehabilitated".  That is possible.

EEM shows divergences, much like the NYSE A-D Line does, when liquidity starts to get tight.  Emerging markets stocks are arguably of lower quality than the big "blue chip" stocks which make up the major averages.  If there is plenty of money to go around, then even the less deserving ones can get some.  When liquidity starts to dry up, the weak get hurt first.

We do not have a divergence now, and that is perhaps even more important of a message than if we did have a divergence.  The lack of a divergence carries the message that the recent price top is likely not the end point for the uptrend.  There can be stumbles along the way, and the start of a war which shuts down shipping from the Persian Gulf is arguably a big reason for a stumble.  But the message is that liquidity was strong going into that event, and so prices will likely recover.  Whether the EEM can recover to a new high remains to be seen, and so we could be seeing the commencement of building a divergence but we do not have it yet.