The Next Big Trade: Asia

by: Todd Feldman

In past articles, we wrote that the summer months would be up and down without direction. So far our prediction has come to fruition. What is important to learn is what the new trade to develop from this up and down action will be. We use our behavioral indicators to determine the next new trade. So far, we have evidence that the Asia markets are the new trade. However, not all Asian market are in bullish territory, which suggests the Asian trade is not fully confirmed. Even so, our indicators suggest to overweight Asia.

Our measures can be interpreted as a type of sentiment measure where the movement is similar to the VIX. The lower the measure the greater the bullishness, and the higher the measure the lower the bullishness. We calculate a sentiment measure for each of the various markets around the world and try to identify the current trade. What makes this measure different is that we find high correlations with the VIX and spread between Baa and Aaa corporate bonds during rational periods in the stock market. However, that correlation dies when markets become irrational. The measure allows us to detect irrational behavior in the stock market. In April we detected irrational behavior in the commodities market and thus sold. However, we are still bullish on a longer term perspective.

Below are the rankings of our long-term and short-term indicators as of July 10, 2011 for purely a subset of the markets we examine. We are looking for transitions. For example, Russia has a high long-term ranking which is a bullish signal. However, the short-term ranking is extremely low which is a bearish signal. This signals that Russia is transitioning from a bull state to a bear state.

The trade for the first quarter and a half of the year was energy. Russia performed quick nicely over that time frame. However, the significant change in the Russian short-term signal signifies that energy trade is over for the time being. In contrast, Indonesia has had a hard time this year, falling over 20% from its high to its low at the beginning of the year. Therefore, the long-term ranking is still somewhat bearish but the short-term signal is bullish. This signifies a transition from a bear state to a bullishes state. Again, we are looking for transitions in order to identify the next new trade. Markets that are not signaling a bearish or bullish state lie in a gray area. This means not to buy or short these markets. Last month on June 11, 2011 the majority of all world markets lay in a gray area. This signified to hold cash and wait until a new trade appears.

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Table 1: BFIA Rankings as of July 10, 2011

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As one can see from Table 1, the markets that are looking to make a nice transition are Malaysia, Mexico, Indonesia, India, and Japan. Four of these five markets are Asian Markets. The other Asian markets, including Korea, Singapore, China, and Thailand, are in a grey area. This means they are in a transition zone. We need to wait and see if these markets are going to move into bullish or bearish territory. If they move into bullish territory we predict that the next trade will be Asia, based on our indicators.

The story behind Asia is that the Asian markets performed quite nicely in 2010. Given the great returns these markets were headed for in 2011, markets such as India and Indonesia were hit pretty hard. Many of these markets are down or are even for the year. In addition, Japan's earthquake was quite devastating for the region.

Now as Japan makes progress revamping its country, the region will begin to prosper again. It is hard to bet on the U.S. market given the high unemployment rate and significant government debt. Europe also has its debt problems. Asia has already gone through its crisis in 1997 and has learned to keep its debt under control. The Asian story as well as our model results suggest Asia as the next trade.

We are just receiving new confirmation of this trade over the past two weeks. If other Asian markets move from gray area to bullishness, this will be a confirmation of the trade.

How to capitalize on this trade? We suggest that when the market is weak to pull the trigger and pick up ETFs that mimic these Asian markets such as EWJ, EWM, INP, EPI, IDX, and EIDO.

The markets will be back and forth for the rest of the summer as we see the debt ceiling talks and European talks come to an end. This will give ample opportunity to pick up shares at a decent price of these ETFs little by little.

Disclosure: I am long INP, EIDO, EWJ.