Emerging Markets Decline with China

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By David Gillie

NEW YORK ( ETFDigest) -- It seems surreal to read a negative headline about China. During a decade of double-digit growth, ETF issuers scrambled to compile holdings in China's booming economy.

Not only was China manufacturing nearly every piece of furniture, toy, gadget and household item for America's insatiable consumer economy, the country was also building its own gigantic infrastructure. China has been the center of the universe and everything revolved around them.

The raw materials for every aspect of manufacturing were drawn from everywhere in the world: petroleum, copper, steel, aluminum, chemicals, rubber, etc. Exporters of these raw materials, many of which were emerging markets, enjoyed expanded economies to meet the enormous demands.

The global recession, which hit a pinnacle in 2008, slowed the demand for China's goods and the ripple effect has hit its suppliers. Furthermore, China's own economy saw such rapid expansion that it became necessary for China to impose slowing to prevent runaway inflation.

China's growth rate slowed to 8.7% in the fourth quarter of 2011. Estimates of first-quarter 2012 are around 7.7% with projections for the rest of the year around 7.5%. These percentages may sound like a dream come true for an American reading this as the U.S. economy claws its way to the hope of 3% growth. However, this represents as much as a 45% decline from the peak of China's growth estimates. Economists are discussing "hard landing" or "soft landing"?

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iShares FTSE China 25 Index ( FXI) has become the gauge many investors use to measure the health of China.

The holdings of FXI are dominated by the Chinese banking industry. As the world went to China to finance their debt, led by the U.S., it's uncertain how much of Europe's defaulting debt is held by Chinese banks. It would be a reasonable assumption, because there were few others with the financial means to support this level of debt, China would have significant exposure.

China is by no means "closing up shop" though. With historic first-quarter gains in the U.S. market, despite economic data to support it, China's market rose in the euphoria. However, FXI lost its momentum at the beginning of March.

FXI stalled through February and formed a double top. This formation is indicative of a position having reached its current upper threshold. Additionally, price had formed an ascending wedge, a bearish pattern, bringing further concern to investors.

A breakout from the second top was an unlikely possibility as all of the indicators had been directionally negative through the month of February and volume had been steadily weakening.

Even with minor upturns on some of the indicators, there's no confirmation the declining trend has bottomed. We don't see any price support until the $33.50 area. Furthermore, what support China is getting from the extreme run up in the U.S. market, will quickly evaporate in any selling of U.S. equities.

Looking back to August on the chart, an oversold condition on the money flow and relative strength indicators triggered some buyers to come in, but FXI had only seen half its decline at that time. That buy lacked confirmation of a bullish crossover on the ADX at the bottom of the chart.

China does not stand alone. Much of the global economy is dependent on China's growth. This is especially so in many of the natural-resource rich emerging markets.

On the chart of EEM, the most largely traded ETF for emerging markets; we can see the "China Effect."

EEM is straddling a support line of $42.00 in a rolling over configuration. Further decline in China could create a breakdown in this ETF heavily weighted to the Chinese economy.

Until China's decline in growth stabilizes, China should be avoided as well as the general emerging market sector. There are, however, individual countries within the emerging markets that will find growth with higher oil prices and potential recovery in the U.S. These individual country ETFs should be carefully hand-picked for their fundamental relation to the global economy and adequate liquidity.

At the time of publication, the author had no position in FXI or EEM, but he held a position in EDZ, a leveraged inverse of emerging markets.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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