• Emerging markets appear to be staging a bullish, long-term reversal relative to the S&P 500.
  • There is plenty of room for further gains, if long-term reversal has occurred.
  • A move above six-year-old resistance in dollar terms is the next bull-market hurdle.

In recent years, the divergence between U.S. and non-U.S. equities has been one of the most interesting anomalies in world markets. From 2010-2017, non-U.S. equities lost more than half their value versus the S&P 500. This is true of all major segments – Developed Europe, Developed Pacific, and Emerging Markets.

Looking back several decades, we note that global markets are subject to wide swings in relative strength. Long periods of massive over-and under-performance are the rule rather than the exception. The swings are presumably caused by variations in business-cycle dynamics. “Animal spirits” are also at play, as relative strength appears to overshoot in both directions.

A few months ago, we discussed the potential for long-term reversal in favor of non-U.S. markets. We noted that Emerging Markets (EM) was the most promising sector, having established early leadership off the January 2016 global bottom. EM’s nascent leadership, however, had stumbled after the U.S. Presidential election, leaving us unconvinced of its durability. Given the mixed evidence, we posited a simple test:

At minimum, we’d like to see relative strength surpass its pre-election threshold. This would constitute a higher high following a higher low, adding confidence to the case for trend reversal.

Flash forward to August 2017. Our initial test has been satisfied. EM has regained its pre-election leadership. See Chart 1.

Chart 1. EM regains pre-election leadership

This does not guarantee that EM will continue to outperform. But it does increase the odds from a trend-following perspective. Markets must stop declining before they can advance. A higher high following a higher low (or retest) is first-order evidence of trend reversal.


Chart 2 adds longer-term perspective. After losing 60% versus the S&P 500, EM has achieved a bullish resolution to an 18-month sideways pattern. This is classic chart evidence of a completed basing process. There is now sufficient reason to adopt a constructive view. At least relative to the S&P 500.

Chart 2. Plenty of upside ahead

The upper panel provides an additional clue. Price in U.S. dollars – another type of relative-strength line – is testing six-year-old resistance near $46 (basis EEM). A convincing move above $46 would provide additional bull-market evidence.

Our focus here is price behavior. But what about fundamental valuation? A market that loses 60% in relative price is probably cheap. This hunch is examined in Chart 3, which compares EM price/sales with U.S. price/sales back to 1995. As suspected, EM is relatively attractive on a fundamental basis.

Chart 3. Relative valuation

So there you have it. EM appears to have turned the corner relative to the S&P 500. A constructive attitude is now warranted from a trend-following perspective. As noted in Chart 2, there is plenty of room for further gains in relative performance. In cases like this, it’s okay to be late to the party.