-Dugald Malcolm, Montreal, Canada

The MSCI Emerging Markets index has posted phenomenal gains since the March 2009 lows. Compared to the MSCI EAFE index, composed of developed countries, the MSCI Emerging Market Index has outperformed by nearly double, with gains of close to 100%. Based upon the added octane of the MSCI Emerging Market, I was curious to see if the recent market pullback was any more pronounced for it than that of the MSCI EAFE Index. This was the case when the markets fell from their 2007 highs. The losses for the MSCI Emerging Markets Index were considerably more than for the MSCI EAFE. To see how it is playing out this time I decided to take a look at charts of the ETFs iShares MSCI EAFE Index (EFA) and iShares MSCI Emerging Markets (EEM), which I will use as proxies for their respective index.

In first looking at the chart, the first thing that catches my eye is the moving averages of EFA and EEM. We can see that the formation of the ominous death cross of the 50 day and 200 day moving average is evident on both charts. Upon closer examination, however, we can see that the cross occurred much earlier on the chart of EFA than it did for EEM. This is because the declines that started in April were much more pronounced for EFA than they were for EEM. Despite the fact that EEM's volatility have resulted in larger relative declines in the past, this time EFA was the one with larger losses, 4% lower than those of EEM. While EFA did recently managed to comeback and test its 50 day moving average, it was not able to rise above it and quickly bounced off and headed lower. EEM, however, managed to not only push back above its 50 day but also its 200 day moving average, despite only being a short lived visit. While EEM is currently just slightly hovering above its 50 day moving average, EFA is considerably below.

While EEM looks to be in better shape relative to EFA, neither are screaming buys. What is of considerable concern is the volume as measured by the POV. The Percentage Volume Oscillator (PVO) is a useful tool in determining the strength of volume as well the directional move of the strength. It examines the percentage difference between the short and long term moving averages of a security or index's volume. On the two charts we see that the PVO for both EFA and EEM fell below the zero line during the rally earlier this month. When the PVO crosses below the zero line it signifies that volume has weakened and is below average. The fact that this occurred as markets began to rally indicates that the rally did not have legs, which was confirmed by the pull back last week. It is also important to note that the PVO for both EEM and EFA are in a distinct downtrend, indicating that volume is continuing to weaken.

While the charts are by no means stellar for either EFA or EEM, EEM seems to show significantly more strength and promise. Ideally I would like to see a breakout of the current downward trend line and a break above the 200 day moving average with a rising PVO above zero before investing. Between EFA and EEM, it would seem more likely that EEM is poised to be the most likely candidate to first fulfil my criteria for investing as well as subsequently providing significantly more returns.