Selling Emerging Markets Humiliation

A street scene in Mumbai.

Vijit Bagh/Pexels

Sell Hubris, Buy Humiliation

As ZeroHedge has pointed out, Bank of America’s Michael Hartnett has been one of Wall Street’s most accurate analysts recently.

Chart via ZeroHedge

In Hartnett’s latest weekly note, summarized by ZeroHedge here, he offered a contrarian trade for 2023, buy emerging markets:

In line with this, his trading recommendation conclusion is, as usualto Sell Hubris, Buy Humiliation:

  • US equities as % MSCI World Index @ new all-time high 66%;
  • Tesla market cap same as entire European banking sector (~$750bn);
  • regime change from Globalization to Isolationism = EM disinvestment + FX devaluation in “weak links” (Sri Lanka -45%, Argy -30%, Turkey -29%, Pakistan -25%, Hungary -24%, Egypt – 19% YTD all despite big rates hikes );
  • trade of ’23 is buy EM humiliation, sell US hubris.
Via ZeroHedge

It’s Not 2023 Yet

As it happened, on Friday, our system took the opposite side of Hartnett’s 2023 trade, including the Direxion Daily MSCI Emerging Markets Bear 3X Shares (EDZ), a leveraged bet against emerging markets, in our top ten names. Regular readers may recall that another leveraged inverse ETF, the Direxion Daily Gold Miners Index Bear 2X Shares (DUST), appeared in our top ten last week.

Having inverse ETFs in our top names and the hedged portfolios constructed from them has helped produce positive returns over the last few months, such as in this hedged portfolio created in July, which included three bearish ETFs, Direxion Daily 20+ Year Treasury Bear 3X Shares (TMV), ProShares UltraPro Short 20+ Year Treasury (TTT), and Direxion Daily Dow Jones Internet Bear 3X Shares (WEBS).

Screen captures via Portfolio Armor on 7/21/2022

That portfolio was up 7.79% as of Friday, while the SPDR S&P 500 Trust ETF (SPY) was down 9.03% over the same time frame.

Maybe We’ll Both Be Right

It’s possible that buying emerging markets will be the trade of 2023 and that we’ll be able to make money shorting emerging markets between now and early 2023 (we aim about six months out with our top names, so April, 2023 in this case). In the event we end up being wrong about EDZ over the next six months though, here’s a way you can limit your risk while betting against emerging markets.

As of Friday, this was the optimal collar to hedge 1,000 shares of EDZ against a greater-than-21% drop by late April, while not capping your possible upside at less than 59% by then.

Screen captures via the Portfolio Armor iPhone app.

As you can see above, the net cost of this collar was $0. To be conservative, that cost was calculated assuming you placed both trades at the worst ends of their respective spreads, buying the puts at the ask and selling the calls at the bid. If you placed both trades within the spreads, you would have collected a small net credit instead.

With this hedge, your maximum upside is nearly 3x your maximum downside. Maybe in April, we’ll be bullish on emerging markets like Hartnett, but for now, we’re selling the humiliation.

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Disclaimer: The Portfolio Armor system is a potentially useful tool but like all tools, it is not designed to replace the services of a licensed financial advisor or your own independent ...

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