Troubled emerging markets near bear market territory

Stocktake: Elon Musk taunts short sellers and GE exits Dow Jones index


Escalating trade tensions between the United States and China have resulted in a torrid few weeks for some emerging markets.

In China, shares fell to their lowest level in nearly two years last week, and are now down 19 per cent since January – just shy of the 20 per cent level commonly used to designate a bear market. China is on the verge of losing to Japan its status as the second-most valuable stock market in the world. Similarly heavy share price falls have been recorded in the Philippines and Indonesia, while Vietnam has already fallen into a bear market.

Should bargain hunters be buying? Not just yet, say some analysts. Morgan Stanley reckons China will have to live with the bear over the next year and cautions Hong Kong stocks risk a “further sharp drawdown near term”, while UBS says a full-blown trade war (a one-in-five chance, it estimates) could knock 30 per cent off Asian stocks.

Despite recent falls, emerging markets have not witnessed the panic selling typically seen at market bottoms. As for valuation, cyclically-adjusted price-earnings ratios confirm emerging markets are much cheaper than the US, but not much cheaper than non-US developed markets. Investors with long-term horizons might like to nibble, but they should also be prepared for the possibility that things get worse before they get better.

Elon Musk continues to bait short sellers

Tesla chief executive Elon Musk continues to indulge in an ill-advised sparring match with short sellers. Musk, who recently warned those betting against the company that they “have about three weeks before their short position explodes”, last week complained in a company email that a former employee had committed “extensive and damaging sabotage” to Tesla operations. There are, he added, “a long list of organisations that want Tesla to die”, ranging from oil and gas companies to “Wall Street short sellers, who have already lost billions of dollars and stand to lose a lot more”.

The notion that shorts want Tesla “to die” is a little hyperbolic. Some shorts certainly reckon Tesla will die, while many others simply believe the company is overvalued. Either way, the portrayal of shorts as shadowy figures bent on destruction is silly. One of Tesla’s chief critics, short seller Jim Chanos, helped expose illegal accounting at Enron, while shorts were among the first to question Lehman Brothers, Anglo Irish Bank, Worldcom, Carillion, Valeant and other troubled companies.

Academic research confirms shorts are good at anticipating trouble. Among companies guilty of financial misconduct, short bets have traditionally tended to rise well before misconduct was revealed. The worse the misconduct, the bigger the position taken by shorts.

Tesla is the most-shorted stock on the US market. The shorts might well be wrong in this instance, but they should nevertheless be recognised for what they are – concerned professionals, not corrupt saboteurs.

GE bids farewell to Dow Jones index

The announcement that General Electric (GE) is to be kicked out of the Dow Jones Industrial Average marks the end of an era for the American conglomerate.

The last surviving member of the original Dow founded in 1896, GE has been a continuous member of the index for more than a century. GE was the most valuable company in the world in 2000, when it was valued at $594 billion (€510 billion). Today, it’s worth a fraction of that ($110 billion/€94 billion), with shares tumbling by some 60 per cent over the past two years.

However, too much should not be made of the removal from the Dow. Firstly, the Dow is an archaic and essentially meaningless index, one with only a fraction of funds benchmarked against it compared to the broader S&P 500. Secondly, note that companies removed from the Dow tend to outperform their replacements over the coming year.

Since 1928, a portfolio of Dow deletions has trounced index additions by about four percentage points a year, according to research conducted by economics professor Gary Smith. That’s because companies usually get the chop after they have suffered a major share price decline, by which time an awful lot of bad news is baked into the stock price.

GE’s best days are clearly behind it, but the next year may yet be a brighter one for its disappointed investors.

History suggests stocks will climb wall of worry

A multitude of concerns – trade wars, emerging markets, rising rates, a flattening yield curve – have weighed on US markets in the first half of this year, but LPL Research strategist Ryan Detrick suggests stocks will climb the proverbial wall of worry in the second half of 2018.

Since 1950, notes Detrick, the S&P 500 has risen by at least 3 per cent between January and the summer solstice on 35 occasions. The full year was positive every single time, with stocks typically posting above-average gains over the remainder of the year. Stocks may well dip in the coming weeks or months, but a 35/35 hit rate suggests any dip should be bought.

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