EMFX Pointing to Better Days Ahead for Emerging Markets?

• One of our favorite EMFX price charts features bullish breadth divergence

• A major sentiment reset in EM stocks could be fuel for better emerging market equity performance

• Higher commodity prices are a tailwind for many EM nations

It has been a strong start to 2022 for emerging market equities on a relative basis. A recovery in some Chinese technology and consumer stocks has helped, along with major strength among resource-sensitive regions in Latin America.

This week’s Global Cross Asset Market Monitor report, sent to clients each Monday morning, summarizes the latest market happenings. And there is a lot of moving and shaking going on right now across the global economy. From expectations of up to seven Fed rate hikes in 2022 to oil prices nearing $100 per barrel on WTI and Brent to fears of a recession later this year, investors are left searching for where to place their bets.

EM Stocks and Bonds Offering Opportunities?

One idea that we have been favorable on is emerging markets. Both the equity and credit spaces are interesting to us. Last week, EMFX moved slightly higher as the Brazilian Real posted further gains. Higher energy prices certainly buoyed some EM currencies.

A Bullish Divergence Detected

Diving deeper into EM stocks and EM forex, we find that an equal-weighted basket of 25 EMFX currencies has been quietly clawing its way back from its lows last December. What makes that move particularly encouraging is that it’s broad-based, as illustrated in the featured chart below. On the technical price chart, there is also a bullish divergence between the EMFX index (price) and the 50-day moving average breadth. We take this as a sign of further potential upside among EM currencies.

Featured Chart: EM Currencies Rallying After a Bullish Breadth Divergence

Higher Commodities Prices Are a Boon

The second wave of the commodity surge is no doubt aiding EMFX, but these currencies are still lagging a bit, so there could be fuel for more room to run. If that thesis holds, there’s also additional upside price risk to emerging market stocks. A rally could make sense given the sharp reset in EM sentiment over the last year.

From Euphoria to Neglect

Recall that EM equities got off a hot start in 2021. Sentiment was also high about this time a year ago – perhaps too euphoric as the EM Composite Sentiment Indicator notched a decade-plus peak 12 months ago. Emerging markets went on to have a dreadful final 10 months of the year as the S&P 500 rocketed higher.

Our weekly report dives into how commodity price action has historically correlated to EMFX moves, but there has been a separation of late. The recent bottoming feature among EM currencies is encouraging for EM stocks that remain in a downtrend from a year ago.

Bottom Line: We see the tactical outlook improving for emerging market equities and FX. Recent relative strength in the EM stock index as well as a bullish breadth divergence among the EMFX index suggest this could be a much better year for this beaten-down asset arena in 2022.

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