Emerging markets, especially those linked to China, are strong shorting targets, says Landon Whaley.
We activated this macro theme on May 6, 2019, to capitalize on equity bear markets around the world as growth continues to slow, and as a vast number of economies experience the most bearish of all Fundamental Gravity environments, Winter.
Korean Canary
South Korea is a critical cog in the global wheel and has always been an accurate lead indicator of global growth. One of the most vital, growth-related, data sets we track is export growth. During July, South Korean export growth contracted 13.6%, versus a 10% decline in June. South Korea is getting slapped by three different economic headwinds. The first is the slowing Chinese economy as exports to China fell by 19% during July. The second is industry-specific challenges in the semiconductor sector as South Korean semiconductor exports fell off a cliff in July, declining 30% year-over-year. The third headwind is the ongoing dispute with Japan. Exports to Japan declined -6.6%, but the tension between the two countries is more evident in the 15% decline in Japanese imports.
Export growth isn’t the only growth-related data set confirming the Winter FG; the vast majority of data out of South Korea is confirming its growth is slowing signal.
On the inflationary side of the FG coin, consumer inflation has found its footing after slowing for seven consecutive months. Unfortunately, both inflation expectations and producer prices continued their year-long downtrend during June. In fact, producer prices grew at just 0.1% year-over-year, which puts them within spitting distance of outright deflation.
The bottom line is that every piece of critical data out of South Korea confirms the Winter FG and reinforces our short bias for South Korean equities.
Wintertime in South Africa
The latest manufacturing data (from May) showed activity had slowed further to just a 1.0% pace of growth. The ABSA (South African) Manufacturing PMI for June confirmed this slowdown, contracting for the sixth consecutive month. The July survey of business confidence (across manufacturers, building contractors, retailers, wholesalers, and new vehicle dealers) declined for the fifth consecutive month and is now sitting at the lowest level in the last three years. This business pessimism was mirrored by the latest reading of consumer confidence, which has now fallen in four of the previous six months (alongside a slowdown in retail sales).
From an inflation perspective, things in South Africa look similar to South Korea. Consumer inflation has flatlined at a multi-year low, but producer prices and inflation expectations both continued their slide.
Here again, the vast majority of data is confirming it’s a Winter Wonderland down in South Africa and indicating only one way to trade South African equities, from the short side.
Focus Market R-2-R
We added the iShares MSCI South Korea ETF (EWY) as a bearish Focus Market on June 3, and as of Friday’s close, that ETF is a down 5.1% and a maximum July drawdown of 10.6% is in our favor.
Down in South Africa, we initiated our bearish Focus Market call for the iShares MSCI South Africa ETF (EZA) on July 1, and it immediately went in our favor with a cumulative loss of 8.7% and a mid-month drawdown of 9.8%. There are few things more satisfying than generating alpha on the short side when several markets are minting new all-time highs.
The Bottom Line
We’ve got Wintry conditions in many emerging market economies, and the U.S. Dollar Index is attempting to bust out to two-year highs. That combo platter is an emerging market short seller’s dream and will continue to provide bearish kryptonite for the equity markets in South Korea and South Africa. A Fundamental Gravity shift out of Winter is highly unlikely for these two economies without a revival of key economies like China, coupled with a materially weaker U.S. dollar, neither of which is likely to occur this year.
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