Should You Short Emerging Markets?

In defence of emerging markets

AMP Capital China Growth Fund [ASX:AGF] is no doubt one of the stocks investors are actively trying to avoid right now. With the massive sell-offs in China and the rest of the world, some Asian markets were off to get some breathing room today. Markets such as China, Vietnam and Hong Kong are celebrating the Lunar New Year. But that hasn’t stopped Japan and Australia from falling through the ‘floor’.

As I read through the letters of discontent on how ‘disastrous’ emerging market stocks have done, one thought crosses my mind. If you are truly bearish on emerging markets — short them.

Or at least go into cash. There is nothing wrong with either choice.

The market is made of individuals, and when the market is volatile investors hold very different views. Then, when markets are doing well, everybody is bullish. And when it is not, everybody is very bearish.

So if you’re in the bearish camp on emerging markets today, go short. Of course shorting is not an easy thing to do.

Try constructing a short-only portfolio first… Go to the ASX and consistently pick out stocks that will go down in value. This is how you construct a short portfolio. Sounds easy right? Not so fast.

Remember, most stocks go up in value in the long term, simply because most businesses create value instead of destroying value over time. Even if they fall, the downside is simply capped by 100% because you can’t lose more than the value of your stock. But the upside is not capped. Stocks can gain multi-hundreds of percent. Think of Commonwealth bank of Australia [ASX:CBA] and BHP Billiton [ASX:BHP]. CBA has gained 200% since the year 2000 and BHP was up almost 600% at the height of the commodity bull market.

It is why our economy grows at positive rates and not negative.

Long-only portfolios are by far the most straight-forward approach to investing for most institutions and retail investors.

Now that doesn’t mean that emerging markets — and in fact the entire global market — aren’t going through a period of downward pressure. Of course they are.

Market excess led to a long bull market, and this is logically now followed by a correction in the form of a bear market. But I have zero doubt that a bull market will resurface. And when it does, emerging markets will offer some of the best gains out there.

In the meantime, if you’ve got the stomach for it, and you’re convinced the rebound isn’t just around the corner, you can always go short.

Ken Wangdong
Emerging Market Analyst, New Frontier Investor

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