Emerging markets primed for a drop

Dropping commodity prices, depressed exports and local currency weakness have combined over the past for years to put pressure on emerging market equities following an initial rebound from the 2008-2009 global economic crisis.

Emerging markets have delivered a relatively poor performance since the beginning of 2011, and technical charts suggest that we could see further weakness in the coming months, with a strong risk of a sharp fall.

Dropping commodity prices, depressed exports and local currency weakness have combined over the past for years to put pressure on emerging market equities following an initial rebound from the 2008-09 global economic crisis.

The MSCI Emerging Markets index, which includes more than 800 securities across 23 markets and represents about 13 per cent of global equity market capitalisation, is the key index to watch here.

From a technical point of view, the index has been registering lower highs since 2008 – unlike developed market indexes, which have been recording successive new high levels.

This weakness in the technical outlook for the MSCI Emerging Markets Index has become even more visible since the beginning of 2011, with the chart of the index values clearly illustrating choppy sideways trading in a tight range. Such price action is usually followed by a strong directional movement.

It is also important to look at volatility for a sign that a major move may be around the corner.

The reduction in volatility over the past couple of years – as demonstrated by the narrowing of the Bollinger bands on the chart – suggests that such a directional move is likely.

Bollinger bands consist of a set of three curves drawn in relation to securities prices. The middle band is a measure of the intermediate trend, usually a simple moving average, that serves as the base for the upper band and lower band. The interval between the upper and lower bands and the middle band is determined by volatility, typically the standard deviation of the same data that was used for the average. Narrowing of the bands can foreshadow a significant advance or decline.

The MSCI Emerging Markets Index has strong support at 900 levels – marked by a trend line that joins previous lows over the past four years. If the index fails to rebound from these levels and breaks down below 900, we can expect a sharp drop towards 700 levels.

This will have a significant effect on global investors. Numerous exchange traded funds (ETFs) are based on the MSCI Emerging Markets Index, which include Brazil, Chile, Colombia, Mexico, Peru, the Czech Republic, Egypt, Greece, Hungary, Poland, Qatar, Russia, South Africa, Turkey, UAE, China, India, Indonesia, Korea, Malaysia, the Philippines, Taiwan and Thailand.

Aksel Kibar is a technical strategist at the Abu Dhabi-based asset manager Invest AD

Follow The National's Business section on Twitter