The dollar is surging, and emerging markets are taking note

Dean Christians

2022-07-18

Key points:

The percentage of emerging market country ETFs outperforming the S&P 500 has fallen to zero
Similar conditions preceded negative returns for an EM index across short and medium-term time frames

Emerging Markets struggle when the dollar index appreciates

In a note on 4/29/22, I shared a study that suggested one should be mindful that emerging markets could struggle when the dollar index surges over a trailing 6-month period. Since the publish date, an EM index has fallen over 10% and underperformed the S&P 500. The environment for emerging markets remains challenging as the DXY continues to appreciate, which Jason highlighted in a note last week.

Let's conduct a study to assess the outlook for an emerging market index after the percentage of EM country ETFs outperforming the S&P 500 over a rolling 21-day period falls to zero, which is the case now. I screened out repeats by requiring the number to increase above 50% before a new signal could trigger again.

For the 1st time in a year and the 19th time since 1996, the number of emerging market country ETFs outperforming the S&P 500 has fallen to zero. While rare, annualized returns are extremely unfavorable when zero EM countries outperform the world's most watched benchmark.

Similar periods of underperformance preceded negative returns

This study generated a signal 19 other times over the past 26 years. After the others, emerging market returns, win rates, and z-scores were unfavorable across short and medium-term time frames. The signal had a negative return at some point in the first 3 months in 17 out of 19 instances.

What the research tells us...

When the percentage of EM country ETFs outperforming the S&P 500 over a rolling 21-day period falls to zero, the broad relative underperformance typically leads to poor absolute returns. Similar setups to what we're seeing now have preceded negative emerging market index returns across short and medium-term time frames. While the dollar index is giving back some of its recent gains today, the uptrend remains firmly in place. As long as that's the case, emerging markets remain in the penalty box.