Some ETF Death Crosses: Where Markets Are Heading and Why

Includes: EEM, EFA, FXI, IEV, SPDW
by: Investment Pancake

US equities markets are very likely in the early stages of a significant bear market. This prognostication is due to several catalysts, some descriptive, some fundamental.

On the fundamental side of the equation, the first major catalyst for a bear market in US equities is the deteriorating economic and financial conditions in China and Europe. In an interconnected world, the US cannot, and does not, stand alone. With the viability of the EU in question, and the entire European continent facing years of slow growth or negative growth due to borrowing excesses, government austerity packages, and other factors, European equities have already slipped into dangerous technical waters.

The iShares Europe 350 ETF (NYSEARCA:IEV) is now demonstrating a classic "death cross" pattern, with the 50 day moving average decisively below the 200 day moving average, and the 20 week simple moving average comparably positioned below the 40 week simple moving average. This story is also being repeated across the developed markets in general - the technical posture of the iShares EAFE Index ETF (NYSEARCA:EFA) mirrors that of IEV.

The emerging markets appear close to joining the developed markets from a market technician's point of view - the 20 week and 40 week simple moving averages for ishares MSCI Emerging Markets ETF (NYSEARCA:EEM) are close to inverting, and the 50 day and 200 day moving averages are coming closer to one another each day. In fact, you can pretty much say that the equities markets across the entire world, with the exception of the US, are now in the first stages of a bear market from a technical analytic standpoint - for instance, the SPDR S&P World ex-US ETF (GWL) shows a classic "death cross" pattern, with the 20 week simple moving average now quite a bit lower than the 40 week simple moving average.

Finally, the Chinese equities market is firmly into technical bear territory - all major short term weekly and daily moving averages on the Shanghia Composite have crossed below their respective long term moving averages (similar technical postures exist for several China ETFs, such as the ishares FTSE/ Xinhua China 25 ETF (NYSEARCA:FXI)).

So, what are the chances that US equities will go their own way, marching to new highs as the rest of the planetary equities markets slump into worsening bear market territory? Pretty slim, I'd venture to guess.

Second, global credit markets are coming under increased strain. The TED OIS spread is growing wider by the week, as inter-bank lending slows and becomes more expensive. The credit default swap market is, once again, booming higher, and the VIX is now technically well positioned to explode higher as well - with various short term moving averages having recently sliced above their long term moving average counterparts. Simply put, there is a bull market forming up in the "bearish trade" market. And if the credit markets take any sudden turn for the worse, we can expect the equities market to do exactly what they did the last time - take a 50% nose dive. At least.

Third, equities valuation is no longer cheap. Taking the average for the past 10 years worth of earnings, the PE ratio for the S&P 500 is roughly 20 or thereabouts, using data compiled by Robert Shiller. That's not extremely expensive, by any means, but it is above average and nearly twice the absolute cheapest levels that equities have seen over the past century.

Forth, the US Dollar is in a bull market. This appears due to the relative strength of the US economy, and growing risk aversion. In large part, the flight from European equities seems to have been exacerbated by the decline of the euro, and if technical analysis of the US Dollar is correct, that course still has a ways to run before reversing. A surge in the US Dollar is bearish for equities in Europe, Latin America and most emerging economies - and that does not say good things about the fate of US equities pricing.

But perhaps the question of why the market is doing what it is doing is far less important than a description of what the market is doing. And that is remarkably easy to describe. The markets are selling off on resistance, bouncing back to lower highs, and then selling off to make lower lows - generally below ever-decreasing support levels. That more or less perfectly describes what a bear market does, and generally, if something snaps and growls like a bear, you are safer assuming that it is, in fact, a bear until proven otherwise.

On the bright side, with most equities markets in oversold territory, a sharp bounce higher is likely to happen within the near term. When is anybody's guess - markets can always go from being oversold to being wildly and implausibly oversold. The more troubling question, though, is how long the bounce back (assuming we see it) will go, and for how long it will last? If the US equities markets join the technical posture of other equities markets, it is safe to assume that any bounce higher will be short lived, and will ultimately pave the way to even sharper subsequent declines.

At a minimum, investors should reduce risk exposure. Traders may find profitable opportunities playing the short side of the market, at least once oversold conditions become less extreme. How far down the markets will go, and for how long, is not knowable, nor are the future news stories that pundits will seize upon to explain the carnage yet to come. The hope is that the US equities markets will avoid slipping into bearish technical territory, and will, perhaps, lift the global markets back from the brink. Hope is a wonderfully expensive investment tool, however.

Disclosure: No positions