Study: don't bet too much on an emerging market bounce and USD pullback


Emerging market stocks have been crushed year-to-date by Trump’s trade war with China.

EEM is a popular ETF for emerging markets. We can use the market’s # of standard deviations below its 20 weekly moving average to see how “extreme” a movement it is. Based on this measure, EEM is pretty “oversold” right now.

Here’s what happens next (historically) when EEM falls 2 standard deviations below its 20 weekly moving average for the first time in 6 months (like right now).

Click here to download the data in Excel.
As you can see, emerging market stocks don’t always go up when it’s as oversold as it is right now. So turning bullish on emerging market stocks just because it’s “oversold” is not a good idea.
Likewise, Grzegorz shared a study on the Facebook group which demonstrated that when EEM is as oversold as it is right now, it tends to go lower in the next month. This suggests that there’s a >50% chance that emerging market stocks will make a bearish divergence before bottoming.


Emerging market stocks and the U.S. Dollar index have a strong medium term inverse correlation right now.

Some people are thinking of shorting the U.S. Dollar just because it is “overbought”. Since emerging market stocks won’t necessarily go up just because they’re “oversold”, the USD won’t necessarily go down just because it’s “overbought.

Conclusion

Emerging market stocks have tanked and the U.S. Dollar has risen in recent months, mostly due to Trump’s trade war. Being bullish on EM and bearish on the USD purely for the sake of being contrarian is not a good idea. I don’t think EM will make a meaningful rally until Trump’s trade war is over.
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