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June 5, 2007
Another Bear Trap or Time For Some Anti-Liquidity Bets?
Having stayed away from the short side of things since a derivatives position in JDSU nearly gave me heart-attack in the late 1990s, it is with some reluctance that I am once again considering an investment a bet against the rising equity tided. What is compelling my interest in a potential short position is simple: there is the possibility of policy overshoot as Chinese regulators aggressively try to slow an equity mania, central banks around the world are eyeing more rate hikes, and there has not been a notable correction in global equities in almost 3-months.
Before continuing it should be noted that short sellers have been burned many times before. Indeed, many bears that have tried to time a correction in equities using a short strategy in recent years have been sapped of the one asset that is essential to have when prices do start falling: cash! In other words, that you can make a lot of money if you time the demise of ‘global liquidity’ right is not as important as recalling that 1-day after Chinese stocks plunged on February 27 Chinese stocks had already bottomed – the exact opposite thing volatility craving speculators thought would happen when they went short on February 28.
With that out of the way, let’s cut to the chase: undercovered/undervalued equity investments are nearly impossible to find and it could be dangerous to churn more cash into a larger precious metals position. And although China’s most recent crash is already well advanced - suggesting that it is already too late to capitalize on the move via a short position - it is interesting to note that the plunge in China has been largely contained. Quite frankly, with emerging market stocks actually rallying since the China sell off began last week, going short this group could be an option (By ‘going short’ that is to say taking a position against the rising trend in equities, not betting against individual companies).
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The Direxion Emerging Markets Bear ETF (2.0X) – which is one way to bet against emerging markets - gained 15.3% on February 27, but the ETF has lost more than 30% since March 5.
But before climbing aboard the short train on the expectation that a meltdown in China will spread to emerging markets, remember that compared to the rallies recent corrections have been exceptionally small. Remember also that the corrections (in emerging markets) have - recently - been exceptionally brief. Trying to stay objective, do EM fundamentals rally suggest that this trend is about to end?
Conclusions and Speculations
As most of you know I am not a proponent of short selling - the 1990s confirmed that the markets can remain buoyant longer than most bears can remain solvent, and since 2003 many bears have been trampled by rising equity prices. Even so, as more bears become bulls and the investment platforms concocted by Wall Street grow increasingly ridiculous (common stock shares are in short supply so don’t fear a U.S. recession?) we could be drawing closer to the end of what has been an historic period of investor risk taking. It is not unthinkable for even the conservative investor to consider taking some risk capital and betting against a potentially extended uptrend.
I stress the word ‘consider’ because despite a plethora of warnings that the equity party is near its peak, the exact timing of the next correction and/or bear market is unpredictable beforehand. What is predictable is that as/if the run-up in emerging market stocks continues the word ‘strongly’ will be placed in front of the word ‘consider’…
What would it take for me to go from strongly considering a short position against EEM to actually purchasing one? 154.2 would probably do it.
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