Emerging Markets: Betting Against Conventional Wisdom

By Eric Roseman

How many investors shorted technology stocks in the late 1990s ahead of the bust in March 2000?

Alternatively, how many speculators bet against bank stocks in 2007 ahead of the historical crash in financial services companies? And how many investors wagered residential real estate prices would collapse ahead of the peak in the summer of 2006?

Betting against conventional wisdom is a risky proposition. After all, investors generally feel more comfortable in a crowd buying the same assets that are appreciating; we’re conditioned to buy en masse and naturally feel comforted by a rising trend that enriches our bank account.

Then the Piper comes calling like he always does when a speculative “bubble” finally draws to an ugly end.

As we shortly conclude the halfway mark in 2009 I’m asking myself “where can an investor make money betting against conventional wisdom?” …In other words, which sectors are seemingly in a speculative “bubble” and absolutely accepted by the masses?

Since the market low on March 9, it’s almost like investors have completely forgotten about the financial crisis. Did it ever exist? Judging by market benchmark performance, mutual fund inflows and investor consensus, the good ole’ days are back.

One sector has gone “punch drunk” since March and deserves a closer look…

My favorite by far is betting against emerging market debt – the best performing fixed-income sector since 1992. Though it might be too early to wager against this booming asset class the payback will be spectacular once a Black Swan, or an unknown event, finally debases this formidable trend.

Over the last three years, a host of emerging market economies have been the beneficiaries of credit rating upgrades by Moody’s, Fitch Ratings and Standard & Poor’s.

Only a decade ago many of these same countries were basket cases – including Russia, which defaulted on its foreign debt as recently as 1998.

Driven by the bull market in raw materials this decade, the emerging markets are now the flavor of the year as over 50% of stock market revenues in this sector are derived from natural resource exports – namely oil.

Soaring commodities prices since 2002 have catapulted this asset class to the big leagues; this undeniable trend is confirmed by the famous acronym developed by Goldman Sachs earlier this decade – the BRICs or Brazil, Russia, India and China.

It almost takes an unlimited pool of capital or a lack of scruples to wager against the BRICs in 2009 – yet this Black Swan has a big payout should it materialize.

Comments

[dondon:]

Just look at the EEM put activity for Sept 09 between $28 and $32.

Jun 23 01:14 PM

[Kumar_kp:]

dondon, both the 32 and 28 September puts have gone down today. Is this a good time to buy either of these?

Jun 24 02:50 PM

[HaavBline:]

What nonsense!

"How many investors shorted technology stocks in the late 1990s ahead of the bust in March 2000?
Alternatively, how many speculators bet against bank stocks in 2007 ahead of the historical crash in financial services companies? And how many investors wagered residential real estate prices would collapse ahead of the peak in the summer of 2006?"

I thought the author was going to claim he did. Scary.

"As we shortly conclude the halfway mark in 2009 I’m asking myself “where can an investor make money betting against conventional wisdom?” …In other words, which sectors are seemingly in a speculative “bubble” and absolutely accepted by the masses?"

How convenient! He feel like it is time to burst a bubble and there it is, a bubble a waiting there to burst by simply for him to go 'contrarian'. Is he talking about a bubble of the century, a bubble of the decade, or just a bubble of mothly variety?

Emerging market debt swooned 40% last fall as the financial crisis spread, while US treasuries rally. The EM debt only recover in sync with the rally from October bottem and has yet to recover to year ago levels.

Is the author calling for a 50% drop from current levels? or just a 10% correction?

Jun 24 04:06 PM

[optionsgirl:]

Bought eev 22 and 23 calls.
Here is a black swan idea- with N. Korea making noises, this is a chilling possibility:
www.pjtv.com/video/Spe.../

Jun 24 04:18 PM

[Ryan Barnes:]

I gotta' go with HaavBline here...this piece is both chuckle worthy and a head-scratcher - the patented "double enigma"!

You can't simply write about mega-hindsight picks without any mention of what you ­actually did then, or what you held, or what you told clients, etc.

The author here seems to be proposing a policy where investors should be on the lookout for "Black Swans" every calendar year. Why? If there was one to find every year they wouldn't be black swan events in the first place. The two mentioned (tech stocks in 99 and housing/financials in 07-08) were essentially a decade apart. Any investor who was told to bet on the nasties in the meantime would have been bleeding premiums for nothing, meanwhile missing out on a pretty decent global market.

And this quote "Since the market low on 3/9, it's almost like investors have completely forgotten about the financial crisis. Did it ever exist?"

This is definitely worth a chuckle to anyone that, oh I don't know, reads the daily newspaper, or turns on the TV for 30 seconds, reads the internet, or picks up their pink slip or foreclosure notice. Pretty sure all those folks aren't doubting the existence or persistence of the financial crisis.

As for the "investing strategy" proposed - which I have to deduce because there's nothing concrete given - it seems that we should be betting against a basket of emerging market sovereign debt. If I were advising clients to do that I'd be filling out my next job's applications right along with it. But go ahead and short 12 emerging market ETFs, and you'll probably get one that goes bust, maybe even two. But on the other 10 or 11, what do you think will be the result when the countries sport 5% annualized, organic GDP growth? I'd say you'll lose much more than your profit on the former.

Sorry folks, I'm not usually a Negative Ned, but this piece seems like a great way to sell a newsletter to scared, tattered investors, and a really poor way to dispense financial advice.

Jun 24 07:54 PM

[The Simple ...:]

What an odd thesis. Going short EM debt is no different in principle from going short any other debt. The analyst must make the case that either (1) a high rate of defaults is expected, or (2) an interest rate spike will decrease the value of the future cash flows, or (3) both 1 & 2 will occur. Debt markets do not trade like equity markets, and contrarian sentiment indicators do not work the same way.

Jun 24 10:52 PM

[Missing_Link:]

EEM is in a very serious downtrend right now. Not sure how long it will last, but I think it's definitely not a good time to buy.

Jun 24 11:55 PM

[Steve in TN:]

I'm not sure if the downtrend is any greater than the SP500 or any other major stock market index. Corrections do happen every few months or so and until proven otherwise it's probably a good time to buy emerging market ETFs.
______________________...


On Jun 24 11:55 PM Missing_Link wrote:

> EEM is in a very serious downtrend right now. Not sure how long it
> will last, but I think it's definitely not a good time to buy.

Jun 25 11:51 AM

[bcncv:]

Lumping together the debt of Brazil, Latvia and India is kind of like lumping together the debt of America, Germany, Japan, and the UK. It doesn't make a lot of sense.

Jun 25 02:52 PM

[maryanne:]

GO BRAC INSTEAD, more specifically Australia and Canada, low debt and strong commodities (hedge against Inflation)

Jun 25 04:40 PM