Investors In Asia More Bearish Than In 2008: Time To Buy?

by: Daily Trading

I’m a contrarian investor, so a mantra I live by is ‘when everyone thinks alike, the opposite is most likely to happen.’

Sometimes being a contrarian means committing to counter-intuitive actions, and current conditions are a classic test of the true contrary investor.

The global markets are highly bearish right now as traders talk-up a repeat of 2008, when Lehman Brothers failed and markets reacted with shock and panic. So you’d think the smart thing to do would be to hedge or position against the downside effects of us revisiting ’08.

Let’s look at some examples of this bearish anticipation: In Hong Kong, the price of Hang Seng China Enterprise Index put options (options to sell the Index in 90 days) have risen over the past few months to their current quote of 1.41 times the price of calls on the Index (options to buy). This is the highest price puts have been relative to calls since 2007!

South Korea’s equities markets has a similar skew in favor of bears: the price of 90-day put options on the KOPSI 200 are now 1.74 times the price of calls; in Taiwan, a 90-day put on the Taiex will cost you 1.53 times the price of a call option on the same index.

Which means that the weight of money is so great on shorting the market that investors are paying a 40-70 per cent premium to make their bets against a market resurgence.

To most people, this is an example of a spooked market, ready for the widely-anticipated repeat of ’08.

But to me, this is a market that is already pricing-in the downside.

And it is nothing like 2008. In that terrible year, very few people foresaw that the subprime debacle would spread so fast and so deep that it would take down Lehmans.

Yet in 2011, Lehmans is all any trader can think of. When they put on their bear hats and wonder ‘how bad can it get?’, they recite as one: ‘2008 and Lehman Brothers – that’s how bad it can get.’

The markets have consequently priced themselves to reflect 2008. This bearish sentiment has caught hold of the markets so tightly that the cost of insuring against downside has risen to 5-year highs.

So what does the contrarian do? One has to start by asking: if everyone is bearish, who else is left to also become bearish and push down prices? If the ‘smart money’ bought puts on the Hang Seng China Index, how many followed the smart guys, to drive the quote to 1.41 times the call option price? Perhaps enough masses to ensure there will not be enough sellers to create the downside they were trying to offset in the first place?

The true contrarian is only happy when he’s standing in the opinion room alone. It’s then that he knows there’s too much money – smart and dumb – standing in the other, crowded room.

I’m looking at the cost of put options on the major Asian indices, and it looks too high, too hysterical. I’m virtually in the room alone on this – could be time to buy the market?

Disclosure: I am long EWH.