Emerging Markets off to a Bad Start

There’s only been five days of trading so far in 2014, but for emerging market equities and for China, the year has gotten off to a very bad start.

The latest declines in both the iShares MSCI Emerging Market ETF (EEM) and the iShares FTSE China 25 Index (FXI) have sent these respective indices below their long-term, 200-day moving averages. This technical development doesn’t augur well for the trend in these sectors, at least in the short term.

EEM is down nearly 5% so far in the young year and, despite a rebound in today’s trade, FXI also is down about 5%. While these sectors are dealing with a variety of different challenges, there is a common thread to the headwinds, and that thread is debt.

In the case of many emerging market nations, their cost of borrowing is going up much faster then their economies are growing. Additionally, many emerging markets are commodity producers, and the low-inflation environment we’ve seen around the world, as well as the slowdown in Europe, have led to a global decline in commodity prices. As for China, that country has its own credit crisis of sorts, as policymakers are trying to rein in credit growth and prevent any kind of runaway debt crisis.

Here at home, the bulls haven’t exactly picked up where they left off in 2013. U.S. stocks actually have started the year off with a thud, trimming a little of the gains off of those record 2013 closing highs.

Right now, there is a lot of bullish sentiment out there. By some measures, the bullish sentiment is near record highs. If the data on the employment, earnings and gross domestic product (GDP) front come in strong, then the bullish sentiment out there may be rewarded. However, if any of these primary economic readings begin to falter, it could be sell-off time for the broader equity market.

As always, the price action in stocks will tell us what we need to know about sentiment, and whether the mood out there is too bullish, or rationally supported.

So, keep a close watch on SPY for clues as to the trend in domestic stocks, and be especially vigilant when watching EEM and FXI, as these two international ETFs will give us a great read on whether the latest pullback is a buying opportunity, or a warning sign.