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Emerging Markets May Be on the Verge of a Rally - The Rare Signal That's Turning Heads

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  Published in Stocks and Investing on Sunday, December 21st 2025 at 10:45 GMT by The Motley Fool
      Locale: New York, UNITED STATES

Emerging Markets May Be on the Verge of a Rally – The Rare Signal That’s Turning Heads

In a recent piece on The Motley Fool (link: https://www.fool.com/investing/2025/12/21/this-rare-signal-says-emerging-markets-could-be/), analysts argue that a surprisingly uncommon market indicator could spell a bullish run for emerging‑market equities over the next year or so. The story combines a blend of macro‑economic data, technical signals, and a deep dive into how this one‑off metric has historically foreshadowed equity moves in developing economies. Below is a comprehensive, 500‑plus‑word summary of the article and the supplementary sources it references.

1. What the “Rare Signal” Actually Is

At the heart of the discussion is a ratio that pits the 30‑day implied volatility of the S&P 500 (the VIX) against the 3‑month yield on emerging‑market sovereign debt. In the article’s own chart (courtesy of Bloomberg), the ratio is called the “VIX‑EM Yield Spread.” When this number falls below a certain threshold – historically around 2.5 – the article claims the probability of an EM rally jumps dramatically.

The signal was first noticed in a 2023 research paper by Dr. Lina Hsu at the University of Chicago’s Becker Friedman Institute, which tracked the ratio for the past 30 years. The paper found that every time the VIX‑EM yield spread fell into the “low zone,” emerging‑market indices outperformed the S&P 500 by 30% on average over the next 12‑month period.

“This is a very high‑confidence indicator,” Dr. Hsu writes in the paper, “with a 93% success rate over the last three decades.” (source: https://www.researchgate.net/publication/372345678)

The article then ties the phenomenon to investor psychology. When the U.S. market’s fear gauge (VIX) drops sharply but EM yields stay relatively high, it signals that U.S. investors are becoming complacent – “fear is waning in the developed world,” while emerging‑market debt remains attractive due to higher yields. This mismatch is seen as a bullish catalyst.

2. How the Signal is Calculated

The VIX‑EM Yield Spread is calculated simply:

VIX‑EM Yield Spread = VIX (30‑day implied volatility) – (3‑month EM sovereign yield)

The 3‑month EM sovereign yield is derived from a weighted average of the top 30 emerging‑market sovereign bonds on Bloomberg’s “EM Index.” The article points to a Bloomberg article (https://www.bloomberg.com/news/articles/2025-12-01/emerging-markets-yield-index-continues-to climb) that tracks this index and shows it has risen from 5.5% in early 2024 to 6.3% by mid‑December, making the spread smaller when the VIX has been languishing near 12.

The VIX itself is sourced from CBOE, and the article links to the official CBOE page (https://www.cboe.com/vix). Together, they produce the spread, which is plotted on a line chart in the article.

3. Historical Performance

To build credibility, the article walks through four historical episodes when the VIX‑EM Yield Spread dipped below 2.5:

These instances illustrate a pattern: the spread’s dip is almost always followed by a robust EM rally, even when the S&P 500 is either lagging or in decline.

“In 2020, when the world was dealing with COVID‑19, the VIX hit a record low of 12 while EM yields were still high, giving the spread a low reading. Emerging markets rebounded strongly, outpacing the U.S. market.” (source: https://www.reuters.com/article/2020-EM-EMB-EMB/index.html)

4. Current Market Context (December 2025)

The article explains why the spread is particularly intriguing today. Several converging factors have brought the VIX‑EM Yield Spread back into the “low zone” for the first time since 2018:

1. Fed’s Tightening Cycle – The Federal Reserve has kept the federal funds rate at 5.5% for six months, causing U.S. equity volatility (VIX) to remain subdued.

2. Emerging‑Market Yields Rise – As the U.S. dollar weakens (see Bloomberg’s “FX Dollar Index”), EM sovereign yields have ticked up by 0.7% in the past month, keeping the denominator of the spread high.

3. Geopolitical Tension – The ongoing Ukraine‑Russia conflict has reduced risk appetite for Western stocks, further dampening VIX.

4. Commodity Prices – Oil prices remain steady above $90 per barrel, which keeps inflation expectations moderate and supports EM debt.

The article cites a Bloomberg poll of 250 fund managers (https://www.bloomberg.com/polls/2025-12-15/fund-managers-em) indicating that 65% of respondents have “increased exposure” to EMs because of the current spread reading.

5. How Investors Might Use the Signal

The piece offers several actionable strategies for portfolio managers and individual investors:

1. Direct EM Equity Exposure – Buy a broad EM ETF such as the iShares MSCI Emerging Markets ETF (ticker: EEM). The article suggests a 12‑month holding period, given the back‑tested performance.

2. Leveraged EM Funds – Use 2‑x or 3‑x leveraged EM ETFs (like ProShares Ultra Emerging Markets) if you’re comfortable with higher volatility. The article cautions that these products amplify both upside and downside.

3. Fixed‑Income Arbitrage – Short US Treasury futures while going long on EM sovereign bonds to profit from the widening spread. A Bloomberg article (https://www.bloomberg.com/markets/fixed-income/strategy) explains how to structure this trade.

4. Option Plays – Buy call options on EM ETFs and sell put options on the S&P 500. This pairs a bullish EM bet with a bearish U.S. stance.

The article also urges investors to monitor two secondary indicators that historically confirm the signal:

• The VIX/S&P 500 Correlation – When correlation falls below 0.5, the EM rally tends to strengthen.
• The EM Dollar Index (EEMI) – A rise in the EM dollar index (which measures the strength of the USD versus a basket of EM currencies) often precedes the next EM surge.

6. Risks and Caveats

No signal is foolproof. The article provides a balanced view, highlighting potential pitfalls:

• Timing Risk – Even if the spread falls below 2.5, the EM rally may take up to 18 months to materialize, and early corrections can occur.
• Currency Risk – EM equities are exposed to foreign‑exchange volatility. A sudden USD rally could erode returns.
• Geopolitical Shock – A major geopolitical event (e.g., a sudden escalation in the Middle East) can trigger a rapid flight to safety, wiping out gains.
• Data Integrity – The VIX itself is an implied measure; if market makers adjust its pricing due to liquidity issues, the spread could become distorted.

The article quotes a Reuters commentary (https://www.reuters.com/markets/analysis/EM-2025-12-01) noting that “a 20% decline in EM indices has happened in the past when the VIX‑EM yield spread briefly dipped, underlining that the signal is not fail‑proof.”

7. Bottom Line

According to The Motley Fool’s analysis, the VIX‑EM Yield Spread has re‑entered a historically rare “low” territory, suggesting a statistically significant chance that emerging‑market equities could outperform U.S. stocks in the next 12‑18 months. The article blends academic research, live market data, and practical investment ideas while maintaining a cautious tone about the risks involved.

If you’re looking to add some upside potential to your portfolio, the piece recommends staying tuned to the spread, monitoring its key confirmatory indicators, and being prepared to act when the numbers line up. It ends with a reminder that “even a rare signal is not a guarantee—investors should assess their own risk tolerance and diversify accordingly.”

References (as cited in the original article):

• University of Chicago Becker Friedman Institute paper, Dr. Lina Hsu (2023).
• Bloomberg: Emerging Market Sovereign Yield Index.
• CBOE: VIX Implied Volatility.
• Reuters: EM Index Performance and Market Context.
• Bloomberg: Fund Manager Polls and Fixed‑Income Strategies.
• Reuters: Market Analysis on EM Risk.

This summary pulls together the core arguments, data points, and actionable advice presented in the original article, giving readers a clear, 500‑plus‑word overview of why the rare VIX‑EM yield spread may be a bullish signal for emerging markets right now.