The NZT-48: This week, I’m discussing why the current macro environment is conducive to shorting the iShares MSCI South Korea ETF (
Fundamentally, when South Korea’s economic equation equals growth down plus rising inflation, EWY has the following performance statistics: average quarterly return is -5.3%; average drawdown is -16.7%; and positive quarterly hit rate is 43%.
Quantitatively, three of the four aspects of EWY’s underlying market structure indicate bearish conditions ahead. Behaviorally, investors remain bullish on EWY, despite a supremely bearish set-up for emerging markets generally and a bearish Fundamental Gravity in South Korea specifically. All three Gravities are aligned and decidedly bearish, which means it’s time to put on a short trade and go huntin’ for wabbit.
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Fundamental Gravity Says What?
Two chief variables impact the risk and return of asset prices: economic conditions and how central banks respond to those conditions. Together, these variables drive what we call an economy’s Fundamental Gravity.
On the growth side of the equation, multiple aspects of the South Korean economy are showing signs of deterioration. Industrial production, which has contracted in five of the last six months, is currently contracting at levels we haven’t seen in over five years. Manufacturing PMI has now contracted for two consecutive months following six months of growth. Manufacturing production has contracted in seven of the last 10 months, and construction output has contracted in four of the last six months.
To put the cherry on top of this slowing growth sundae, exports fell off a cliff in April, contracting for the first time since 2016. Ouch!
For the uninitiated, South Korea has historically been a reliable bellwether for global demand and growth. This latest string of economic data speaks volumes about the bearish trajectory of South Korea, but it’s also a read-through on the trajectory of the global economy. Keep in mind that South Korea is not alone—export growth in Taiwan, Indonesia, and Thailand has also slowed since peaking in December.
On the inflation side of the equation, all three measures of inflation (core, consumer, and producer prices) are accelerating month after month.
The Fundamental Gravity bottom line is that when South Korea’s economic equation equals growth down plus rising inflation, South Korean equities head south.
Quantitative Gravity Says What?
As a quick reminder, the Quantitative Gravity component of our Gravitational Framework is not technical analysis, which can be ineffective and misleading. Rather, we use quantitative measures based on the reality that financial markets are a nonlinear, chaotic system.
We’ve identified four primary quantitative dimensions of financial markets that affect price movement: energy (trend), force (momentum), rate of force (buying pressure), and a market’s irregularity.
Social is our measure of a market’s current energy (or trend). EWY’s Social reading indicates that it’s taking a breather from a hangover. Remember, markets don’t go straight up or straight down. The downtrend in EWY has halted for now, but the most likely direction moving forward is south.
Momo is our measure of the amount of force behind the market’s current state. EWY’s Momo turned negative on February 5 and has spent every trading day since building bearishly.
Barometric is our measure of the rate of force behind the current MOMO. EWY’s Barometric tells us that sellers have been in complete control of this market since March 23, and selling pressure continues to build.
Topo, which measures the probability of a drawdown, is contradicting the other quantitative factors and indicates a low probability of a drawdown over the next 10 trading days.
Most investors are hyper-focused on price action. Unfortunately, price is nothing more than the current point where there are equal parts of disagreement on value and agreement on price.
If you’re new to our Quantitative Gravity framework, it’s important to note that the four quantitative dimensions of a market we monitor typically move ahead of price. In other words, price is the last aspect of a financial market to move, quantitatively speaking. However, price is an important factor, and my bearish thesis for South Korean equities will remain intact as long as EWY trades below $74.91.
The Quantitative Gravity bottom line is that three of the four aspects of EWY’s underlying market structure indicate that lower is the most likely direction for price. While we prefer all four aligned, as the old Meat Loaf song goes, “three out of four ain’t bad.”
Behavioral Gravity Says What?
Behavioral Gravity allows us to evaluate investors’ perception of this market and how that perception changes and shifts over time.
In 2018, retail investors have added approximately $128MM to EWY, indicating that investors either believe South Korean growth slowing is transitory or that the U.S. dollar’s strength is short-lived. Most investors have very little insight into what’s truly going on fundamentally, which is confirmed by a bullish bias on South Korea.
The Behavioral Gravity bottom line is that investors remain bullish on EWY, despite a supremely bearish set-up for emerging markets generally and a bearish Fundamental Gravity in South Korea specifically.
Landon Whaley is editor of the Gravitational Edge and CEO of Whaley Capital Group.
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