Emerging markets are now the market du jour. It makes sense: The MSCI Emerging Markets Index is up 25 percent year to date, vs. a 10 percent gain for the S&P 500. But there's still reason to be skeptical. The last 10 years have been a lost decade for emerging markets, so a lot of investors are asking themselves, Sell the rally, or expect more gains? The charts tell us there is more upside to come.

We use a weight-of-the-evidence approach to technical analysis, evaluating many different indicators and seeing what the total picture looks like. This helps us avoid falling in love with one data set or avoiding an investment because of just one negative.

The absolute price trend of emerging market stocks has been positive since late 2015, with a few normal pullbacks/corrections. This trend is well established, as there have been multiple points where stocks pulled back, only to subsequently break higher—the “classic” higher highs and higher lows. From May to mid-July, emerging market stocks "paused" after nearing resistance levels last seen in 2014-2015 and subsequently broke higher after a two-month trading range. This absolute price strength, accompanied by relative strength against developed international (MSCI EAFE, blue line below) and U.S. stocks (S&P 500, purple line), provides an indication of emerging markets' global leadership profile. In our opinion, this profile is important—not only does it confirm their strength, but as other global markets stall and/or decline (i.e. Europe), this strength provides investors with an “easy” segment to rotate into.

Chart source: Bloomberg LP & HighTower Global Investment Solutions

The long-term momentum for emerging market stocks is positive, and over the last 12 months, momentum has moved from bearish to bullish. The Relative Strength Index (RSI), a common momentum indicator, is above 70, which the casual chart watcher may consider to be overbought. In a bull market, the levels associated with overbought and oversold conditions usually shift up to 40 and 80 (as opposed to typical 70/30 levels). Given this shift, emerging markets are near overbought, but well within the expectation for a cyclical bull market.

Momentum in a bull market can be challenging—overbought conditions often stay elevated for a significant amount of time, making it difficult for those waiting for a pullback to enter, as the strong market continues. We are not yet concerned about the momentum profile.

Chart source: Bloomberg LP & HighTower Global Investment Solutions

Breadth is a key input to our technical view—while price can move higher for many reasons, if it's not supported by strong breadth, our skeptical nature starts ringing the alarm bells. Current breadth measures (percent above 200 day moving average and new 52-week highs/lows) confirm our view on the price trend for emerging markets, and importantly, suggest there is still room for increased participation, and therefore strength in the trend. Another reason we focus on breadth is because tops in equity markets are usually preceded by declining breadth. For instance (shown by arrows in the following chart) breadth weakened prior to the peaks in 1999-2000, 2007 and 2011.

Chart source: Bloomberg LP & HighTower Global Investment Solutions

Another way we like to verify strength in emerging markets is by looking at other emerging market assets or, in other words, using intermarket analysis. We like to evaluate emerging market bonds and currencies to see what other types of investors and markets are “telling us” about their view of emerging market risk. When looking at currencies and bond spreads (emerging markets yield minus U.S. treasury yield, a proxy for strength vs. treasuries), we see both trends are in our favor, providing confirmation of our positive view on emerging market assets.

Chart source: Bloomberg LP & HighTower Global Investment Solutions

The Bottom Line

Generally, we are long-term bulls on emerging markets—our perspective is that emerging markets are the growth engine of the world, demographics are attractive, the market is extremely inefficient and U.S.-based investors are perpetually underweight in emerging market equities. Despite the ~50% gain over the last 18 months, the technical profile we observe suggests investors can continue to benefit from increasing their emerging market allocations.

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Matthew Harris is an investment professional registered with HighTower Securities, LLC, member FINRA, MSRB and SIPC & HighTower Advisors, LLC a registered investment advisor with the SEC. All securities are offered through HighTower Securities, LLC and advisory services are offered through HighTower Advisors, LLC. This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources. HighTower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of HighTower Advisors, LLC or any of its affiliates.

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