EEM: Trade War, US Dollar, and a ‘Golden’ Opportunity

In November so far, the iShares MSCI Emerging Markets ETF (EEM) has risen 0.9%. Early this month, optimism surrounding US-China trade talks may have supported emerging market equities. Yesterday, however, the Shanghai Composite Index fell 0.8%. Rising pessimism about Phase 1 of the US-China trade deal may have driven the decline. EEM has the highest exposure to China.

To learn more, please read Is Phase One of the US-China Trade Deal in Trouble?

EEM: Trade War, US Dollar, and a ‘Golden’ Opportunity

EEM’s exposure in China and other markets

EEM has exposure of around 32.1% to Chinese equities. Alibaba (BABA), Taiwan Semiconductor Manufacturing Company, and Tencent Holdings constitute around 4.7%, 4.5%, and 4.3% of EEM’s total portfolio, respectively. Furthermore, the ETF has exposures of 12.4%, 12.1%, and 8.7%, respectively, to South Korea, Taiwan, and India. It also holds mid- and large-cap stocks from countries including Mexico, Indonesia, and Malaysia.

Emerging market PMI

In October, China’s Caixin Manufacturing PMI (purchasing managers’ index) was at 51.7, higher than expected by a Reuters poll. However, the country’s official PMI was below 50. A reading of above 50 indicates expansion in manufacturing activity. Read US and China PMIs Diverge: What’s Really Happening? to know more.

Last month, India’s IHS Markit manufacturing PMI was at 50.6 compared to Reuters’s consensus of 51.8. In fact, it was at its lowest reading in the last two years. Moody’s also recently downgraded India’s credit rating outlook. The country’s economic growth is sagging near multiyear lows. A further slowdown in the Indian economy could adversely affect EEM. While India is expected to benefit from the US-China trade war, not many US companies operating in China have shown their willingness to shift operations there. 

The US dollar has strengthened in 2019

In 2019 so far, the US dollar has strengthened by 0.6%. Several emerging market currencies have weakened against the dollar this year. According to CME’s FedWatch tool, there’s a 97.8% probability that the Fed will keep interest rates unchanged in next month’s meeting. Moreover, until March, traders don’t expect more rate cuts by the Fed. Usually, if a central bank reduces interest rates, the domestic currency falls compared to foreign currencies. Similarly, a hawkish central bank might push the domestic currency higher than its foreign counterparts.

Weaker emerging market currencies are a double-edged sword. On the one hand, a weaker currency makes fresh dollar investments more attractive. On the other, the dollar value of an existing investment in an emerging market falls when its currency depreciates. President Donald Trump prefers a weaker US dollar, as it supports exports. The Trump administration labeled China an official currency manipulator in August after the Chinese yuan tumbled against the US dollar. EEM also came under pressure in August amid escalation in the US-China trade war.

EEM’s 20-day average may signify short-term weakness

Yesterday, EEM was trading 2.1%, 3.1%, and 2% above its 50-day, 100-day, and 200-day moving averages, respectively. However, it was trading 0.4% below its 20-day moving average. If its price stays below its 20-day moving average, it could see short-term weakness. Its 50-day moving average is on par with its 200-day moving average. In August, amid the trade war’s escalation, its 50-day moving average fell below its 200-day moving average. 

Technically, when a 50-day moving average moves decisively above a 200-day moving average, it’s called a “golden cross.” Usually, it’s considered a positive development for a stock.