Technically Speaking: U.S. Dollar Strength Adds Pressure to Emerging Markets

The recent depreciation of the Turkish lira has increased volatility in global markets. Other foreign currencies such as the South African rand have followed suit, leading to U.S. dollar strength and more pressure on broad-based emerging markets.

As shown in our LPL Chart of the Day, from a technical analysis perspective, we’re beginning to see potential long-term trend reversals on both the U.S. dollar and the MSCI Emerging Markets (EM) Index. The U.S. dollar monthly price has remained above its 12-month moving average (MA), an indicator of long-term trend, for more than three months, which increases the likelihood that a bullish trend potentially has room to run higher. One outcome of the greenback’s strength is that the MSCI EM Index has moved lower, closing below its 12-month MA for nearly 3 months, which suggests that the year-to-date bearish momentum may also persist.

An Upward Trending U.S. Dollar Increases Pressure to Emerging Markets

Looking at historical data going back to 2008, out of a small sample size of six, when the U.S. dollar price operates above its 12-month MA, the MSCI EM Index tends to underperform the U.S. benchmark (Russell 3000 index) 67% of the time and by an average of 5.5%. The study also reflects a large dispersion in the data minimum and maximum values, at -29.6% and +24.8%, respectively, which suggests that when the U.S. dollar trends higher, volatility in the emerging markets is likely.

Since its moving average crossover on May 31, the MSCI EM Index has underperformed the Russell 3000 index by approximately 12.5%[1], which is more than the average value in the study. One school of thought may interpret this as a potential signal that the sell-off and underperformance in the emerging markets may be coming to an end, and investors should be looking for the beginning of a bottoming process for the asset class. However, based on historical data, long-term trends tend to persist for months, and we may experience increased volatility within the emerging markets before the bottoming process begins. Based on our Midyear Outlook, we still expect emerging markets to make it through these volatile times and once again become a leading asset class for suitable investors to invest in. Our strategic outlook for allocation to the emerging markets in applicable models/strategies remains intact.   Please stay tuned to the LPL Research blog for future updates on the U.S. dollar and emerging markets.

IMPORTANT DISCLOSURES

The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.

The Russell 3000 Index measures the performance of the 3,000 largest US companies based on total market capitalization.

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[1] As of August 16, 2018