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Emerging Markets Mean Reversion Opportunity

Dean Christians
2021-10-18
On Friday, 10/15/21, two models for emerging market stocks issued a buy signal at the close of trading. Let's review the outlook for a broad-based index allocation to emerging markets.

On Friday, 10/15/21, two models for emerging market stocks issued a buy signal at the close of trading.  In my Monday morning absolute and relative trend updates, I've noted that a few emerging market countries like India and Saudi Arabia look good. However, the weight-of-the-evidence has suggested that one should avoid a broad-based index allocation.

Emerging markets have two adverse factors that are currently weighing on the indexes. The first is a positive dollar trend, which I highlighted in a note on 8/20/21. The second unfavorable factor for emerging markets is monetary tightening by several central banks, which I highlighted in a note on 10/6/21. 

Let's review the results for the following models to assess whether we should change our outlook on emerging markets from unfavorable to favorable.

EMERGING MARKET MODEL SIGNALS

  1. Average True Range Spread Model
  2. Breadth Composite Model

AVERAGE TRUE RANGE SPREAD MODEL

Please click here for the original Average True Range Spread buy signal concept note. The following link contains a second note on the ATR Spread concept. Click here.

AVERAGE TRUE RANGE SPREAD CONCEPT

The average true range spread signal identifies when a stock, ETF/index, or commodity reverses from a period of high volatility to low volatility in a user-defined number of days. 

CURRENT DAY CHART

TRADING STATISTICS

The trading statistics in the table below reflect the optimal days-in-trade holding period of 42 days. When I run optimizations for trading signals, I cap the max number of days at 42. i.e., I optimize to find the best DIT holding period between 5 and 42 days.

HOW THE SIGNALS PERFORMED

The results look excellent across all time frames, with several significant risk/reward profiles, especially the 1-month window.

BREADTH COMPOSITE MODEL

The following breadth composite is constructed from the 44 countries USD-based ETF series that I share in my Monday ETF updates. The emerging markets composite contains participation-based indicators from 22 countries.

BREADTH COMPOSITE INDICATOR COMPONENTS

  • Percentage of EM countries above the 10-day moving average
  • Percentage of EM countries above the 50-day moving average
  • Percentage of EM countries above the 200-day moving average
  • Percentage spread between 21-Day highs and lows for EM countries
  • Percentage spread between 63-Day highs and lows for EM countries
  • Percentage spread between 252-Day highs and lows for EM countries

BREADTH COMPOSITE CONCEPT

The composite breadth signal identifies when the composite surges above a user-defined threshold level. The model will issue an alert based upon the following conditions.

SIGNAL CRITERIA FOR EMERGING MARKETS

  1. If the composite breadth indicator crosses below 0%, then the reset condition is active. 
  2. If the reset condition is confirmed and the composite breadth indicator crosses above 52.5%, then buy.

CURRENT DAY CHART

TRADING STATISTICS

The trading statistics in the table below reflect the optimal days-in-trade holding period of 41 days. When I run optimizations for trading signals, I cap the max number of days at 42. i.e., I optimize to find the best DIT holding period between 5 and 42 days.

HOW THE SIGNALS PERFORMED

Results look solid across almost all time frames. While several risk/reward profiles are good, the one and two-month windows are excellent. And, I would note that the 2-month window has registered 16/18 positive gains since 2008.

Both models' performance and risk/reward profiles look good enough to suggest that one should consider a mean-reversion opportunity in an emerging market ETF. However, given the dollar and monetary policy backdrop, I view the opportunity as a short-term rent versus buy-and-hold strategy.

As always, this note is not a recommendation but rather a complementary tool to your investment process.

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