EM is clearly exhibiting negative technical momentum, as the EM Index has broken below its 50-day and 200-day moving averages—and those averages are downward sloping. Momentum is only one way to employ technical analysis (not to mention the fact that there are many different flavors of momentum), and relative strength analysis of EM versus the S&P 500 Index may not give you a complete picture. However, we can look at the price ratios of other assets for additional insight on emerging-market stocks’ future path.
The price relationship between gold and silver stands out to us right now. The gold-to-silver ratio measures how many ounces of silver it takes to buy a single ounce of gold. The spread was above 85 recently, which was the highest since late 2008, when the financial crisis began.
As Figure 2 shows, the previous three times the gold-to-silver ratio was near 80, the MSCI EM Index was near a low. Additionally, the EM Index is near a major trend line of potential support. Only time will tell if this scenario plays out again, but it’s worth watching as a potential bullish signal for EM and a possible rotation into riskier assets.
Other Gauges Of Sentiment
Here are some other factors to consider when gauging sentiment in EM:
• Significant U.S.-EM divergence. EM has not diverged this much from the U.S. stock market since the mid-1990s. While this gap could close if U.S. stocks drop, we expect it to be resolved through EM gains.
• Weak breadth nearing a contrarian signal. About 35 percent of stocks in the MSCI EM Index are below their 200-day moving averages, not far from the 20 percent level where EM has typically bottomed out (as was the case in early 2016).
• Low valuations. Simply put, we think a lot of bad news is priced into EM stocks, especially given the mostly favorable economic backdrop and positive earnings growth outlook.
Though just one small data point, we were encouraged by EM’s resilience on Friday after the strong wage growth number in August’s employment report sparked fears of accelerated Federal Reserve (Fed) rate hikes. Latin American markets, including the influential Brazil, have perked up lately, which is a positive sign.