By now I think everyone has had the opportunity to see that US Stocks are outperforming Emerging Markets Stocks. This has been going on since early in the Fall of 2010. It’s not a secret. But the action in the $EEM:SPY ratio over the last couple of months tells me that something could be changing.
I am not an ‘oscillator junkie’ by any means. In other words, I don’t look at 20 indicators and wait for them all to align perfectly before making trading decisions. I’m more of a keep it simple stupid kind of guy. The relative strength index is really the only oscillator that I follow on a daily basis. Even though price is the only thing that pays, and is still the priority, I always consult my 14-period RSI before making trades.
We are now coming off the most extreme oversold reading in the history of the $EEM:$SPY ratio (it goes back to 2003). But more importantly, the ratio just put in a lower low while RSI held in nicely and made a much higher low staying out of oversold territory. A bullish divergence like this will always grab my attention (I wish they happened more often).
Two things we can take from this. You can trade the ratio – Long $EEM and Short $SPY. Or, like me, you can watch this ratio as a guide for the direction of the market as a whole. If you think that stocks are going higher, then you want to see money flowing into emerging markets at a faster rate than US markets. You want to see money looking to be aggressive, not conservative. Risk-on, not risk-off right? If $EEM starts to outperform $SPY from here, this bodes very well for the Stock Market and Commodities going forward.
The beauty of this reading is that if the ratio rolls over and makes new lows (RSI will do so simultaneously) and we’ll know that we’re wrong nice and early. But for now, it looks great. We want to see some confirmation by the ratio trading back above 0.31 (or if you’re looking at the opposite $SPY:$EEM – back below 3.23)
Go get ’em!