I'm Still Waiting on Emerging Markets - What Happened?

I am waiting for the opportune time to short emerging markets, but now is not the time. It may be time in a week or a month or a year, I don't know, but it is not right now.

I have three rules about shorting - valuations are high, conditions are deteriorating or will do so soon, and the technicals are weakening. If you are investing on the long side, the latter two are not necessary if you are patient as valuations will bail you out eventually. That is not necessarily the case, however, when shorting.

For emerging markets, the first condition is definitely present. The second will become prevalent soon, as I do not believe emerging markets are decoupling. But I'm not so sure about the third.

My vehicle of choice on the short side is to buy the ProShares UltraShort Emerging Markets ETF (EEV), which inversely tracks the MSCI Emerging Markets index by a factor of two. Currently, the MSCI Emerging Markets index shows no signs of slowing.

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One can get a better understanding of the action in a broad index by looking at its components. If the components of an index are breaking down while the index continues to rise, the rally is becoming narrower and less healthy.

Fifty-five percent of the MSCI Emerging Markets index is made up of four countries - China (16% of the index), Korea (16%), Brazil (12%) and Taiwan (11%).

The markets of each country are as follows:

China

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China had perhaps its most meaningful correction since it began its ascent a few years ago. It may be just a dip in a long-term uptrend or it may be the beginning of a top. However, in the near-term, the market is very oversold, and at the very least, will bounce to work off the oversold condition. A test will come when the Shanghai index approaches its 50-day moving average (the blue line).

Korea

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Korea may be in the process of forming a top. However, it bounced off the 200-day moving average (the red line) and is approaching the 50-day still while in an oversold condition, suggesting that Korea is likely to power through resistance, which bodes well for the MSCI Emerging Markets index.

Brazil

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Bullish is the only word to describe Brazil as it sits at its all-time highs. Brazil shows no technical signs of slowing.

Taiwan

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Taiwan is most worrisome as it looks most like the market that is topping. However, it is deeply oversold and will bounce. The question is whether it will hit new highs or roll over as it approaches old highs.

Thus, Brazil is very bullish, China is bullish but must be watched while both Korea and especially Taiwan may be topping.

Four other emerging nations make up 28% of the MSCI Emerging Markets index - Russia (9%), India (7%), South Africa (7%) and Mexico (5%).

The graphs of each nation are as follows:

Russia

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India

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South Africa

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Mexico

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The uptrends are in tact for the first three while there are questions about Mexico, which may be topping or may be consolidating.

I think the risk/reward profile for emerging markets is very poor now. Yes, they are high growth stories, but so was America in the 19th century but it also experienced many booms and busts. Today's emerging markets will be no different, especially when so much of the capital driving the emerging markets higher is flighty hot money.

However, at the moment, the technical picture is strong. If it rolls over tomorrow, then the conditions to short will have improved. But until it does, it pays to wait.