If you consider the number of stocks, bonds, mutual funds, and ETFs on the market, investors face an endless combination of portfolio choices. Once we focus on a specific item, we can take one of three main stances-long, short, or neutral. For months, the portfolio created in my weekly newsletter EPIC Insights held positions in the ETFs of commodity-producing nations. Last week we altered our stance and moved from long to neutral as it appeared that prices were topping. That call was clearly correct. Of the ETFs we owned, the iShares Australia Index Fund (EWA) was sold at $16.82 and closed the week at $16.22 (3.6% execution gain), the iShares Canada Index Fund (EWC) was sold at $21.81 and closed the week at $21.26 (2.6% execution gain), and the iShares Brazil Index Fund (EWZ) was sold at $53.99 and closed the week at $52.20 (3.3% execution gain). Having correctly made the journey toward neutrality, we will now take the next step and examine the merits of going short.
As I said last week, I felt that the Brazilian and Australian markets were the weakest. With uptrends broken and moving averages under assault, both markets were showing the early stages of a head-and-shoulders reversal. This week, that process was completed.
Looking at the individual charts, Brazil, which is one of the strongest markets this year, has exhibited a powerful uptrend since December (black line) which resulted in a 60% gain in less than one year. That trend is now broken. Alone, the failure of a steep trendline would not turn me bearish. However, the head-and-shoulders top (red arrows) does. With Brazil having carved out such a pattern, the likelihood of new highs is remote while the possibility of a steep drop increases. Based on the chart, I expect weakness to continue with pricing falling toward 44,000 (red box). If I am incorrect, prices should better the recent high of 54,486. With these two price targets, we see an upside of 14% and a potential loss of 7%. With the gains skewed in our favor, a short position is warranted.
Turning to Australia, we see a similar story. The strong uptrend (black line) has been broken and the index has fallen below its 50-day MA. Also, the head-and-shoulders process (red arrows) completed last week points to lower prices in the future. I have established an interim price target of 3,400 (red box) and would consider the reversal process nullified if the index rose above its recent high of 4,062. These price targets offer potential gains of 11% versus a loss of 6%. With the risk/reward in our favor, a short position has great merit.
To short each of these markets, I will be using the same ETFs which allowed us to ride the rally higher. I recommend short positions in EWA and EWZ as this week's technical trade.