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You Could Short China At This Point, But It’s Not For The Fainthearted

Chinese stock markets could be set to fall by 50 percent. Given concerns of a stock market bubble in China, I take a bearish view on Chinese equities at this point in time. The ProShares Short FTSE China 50 ETF could potentially provide an opportunity to take advantage of a downturn. However, this strategy carries high risk given the degree of volatility inherent in Chinese stock markets. Once a booming economy at which a growth rate of below 8 percent annually was unheard of, things have certainly been changing for China in the past five years. Stock markets in China have certainly seen periods of abnormally high returns. However, such returns have come with significant volatility and sustained growth has remained elusive. For instance, the Shanghai Composite Index (000001.SS) has seen significantly high returns in the past year, up over 100 percent from the beginning of 2014 to May of this year. However, the trend now appears to be reversing, with the index having lost as much as 12 percent since the beginning of June, along with various experts predicting that the index could in fact fall by 50 percent. While I had previously commended China’s rise in stock prices and was optimistic on its continuation, I am less so in light of the recent volatility. Firstly, high stock market returns have not been matched by correspondingly high growth. China’s stock markets appear to have been taking a similar course as that of Europe, where quantitative easing and lower interest rates have forced investors to seek higher returns in the stock market. Moreover, this situation is being exacerbated in China given that returns from the property sector have been significantly lower than in previous years. In this context, I take a bearish view on China at this point in time. Given the historical nature of volatility across Chinese stock markets, the market appears to be at a significant risk of correction. This is especially possible given that stock returns are increasingly being driven by margin; i.e. investors are now borrowing to fund their positions. Should contagion develop in China and investors pull out their funds, then it is quite conceivable that a 50 percent drop would be possible under such circumstances. While a 50 percent drop seems rather drastic, it would not be that unusual when taking into account that the Shanghai Composite has already appreciated by over 100 percent in the past year. Moreover, China’s stock markets have precedent for demonstrating that they are not immune to contagion, with the Shanghai Composite having dropped almost 60 percent between 2007-08 in spite of higher economic growth rates above 8 percent at the time. Additionally, with China trading at a cyclically-adjusted price-earnings ratio of 20.5, this is significantly higher than the overall emerging markets ratio of 16.5. In this regard, China’s stock markets are likely overvalued and could be due for a pullback. While China’s quantitative easing has spurred increased investment in the stock market due to lower borrowing costs, this is unsustainable and there is always a risk of a sharp pullback in response to a rise in US interest rates, as investors seek more stable returns elsewhere. For investors wishing to take advantage of a specific short position on Chinese stock markets, one way of doing so is through the ProShares Short FTSE China 50 (NYSEARCA: YXI ), which has returned over 7 percent since the beginning of May. This ETF corresponds to the inverse of the FTSE/Xinhua China 50 Index and has succeeded in capturing a broad downturn in the Chinese market over the past two months. However, a significant risk remains in that investors would likely have to time the trade very well; returns on the ETF as a whole have been negative. Moreover, 5 of the 10 largest companies on the index originate from the financial sector. In this regard, it is likely that stock performance would move down in response to a broader economic downturn in China. However, with Chinese banks gaining traction internationally, it could be the case that this in fact lifts stock market performance higher. To conclude, I take an overall bearish view on the Chinese stock market at this point and a short opportunity likely exists. However, investors would likely endure significant volatility in doing so which would make this quite a risky trade. Disclaimer: Investing in emerging markets carries a high degree of volatility and as such, the above strategy is not recommended for conservative investors. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Left Smarting – Smart Beta Products May Not Make Bad Decisions But They Do Facilitate Them

By Kevin Murphy ‘But guns don’t kill people, people do’ is a line less likely to settle an argument than provoke further discussion and yet it is not impossible to imagine an advocate of so-called ‘smart beta’ investments – strategies that try to build on simple index-tracking products by focusing in on a specific factor, such as growth, momentum or value – using a similar refrain. “But smart beta products don’t make bad investment decisions, investors do,” they might tell a doubter. To which we would reply – as we would to anyone trying the gun line – “OK, but they do make the job a lot easier.” We touched on this idea of smart beta products exacerbating investors’ well-documented inability to judge when to buy into and sell out of markets in, among other articles, Smart thinking . That piece was inspired by some fascinating work by our friends at Empirical Research Partners and, since they have recently returned to the subject, we shall too. What Empirical has done is to look at two relationships – first, between past performance and where investors put their money and, second, between where investors put their money and subsequent performance. As you can see from the chart below, for eight out of the 11 categories of smart beta strategies analysed, there is a very strong positive correlation between past performance and future fund flows, with those directing money towards yield-type exchange traded funds (ETFs) apparently the most prone to invest with at least one eye on the rear view mirror. Source: Strategic Insight Simfund, Empirical Research Partners Analysis, June 2015 Here on The Value Perspective, we have no major philosophical issue with investors putting money into areas that have performed well, if – and it is a big if – they continue to perform well. So did Empirical identify any sort of positive relationship between performance in consecutive quarters? Did funds that performed well continue to do so? The answer, as you can see from the following chart, is ‘not really’. Source: Strategic Insight Simfund, Empirical Research Partners Analysis, June 2015 Indeed, returns to yield ETFs are so mean-reverting that, as Empirical observes: “If anything, investors should be buying them after down-quarters rather than up-quarters.” As value investors, we also cannot resist pointing out how momentum ETFs have a negative correlation here too – after all, the one quality investors might think they could count on from such a strategy would be, well, momentum. One final aspect of Empirical’s research we would highlight is the finding that, on average, smart beta strategies turn over about a third of their total capitalisation every month. This would of course imply the average holding period for a smart beta investor is three months – in other words, the average holding period mirrors the time frames of fund flows and performance discussed above. The picture being painted here is of a dispiriting and, to our minds, frankly nonsensical investment routine, where your average smart beta investor sees good performance, buys it, sells up after a quarter of likely disappointing performance, buys something else that has performed well, sells up after a quarter of likely disappointing performance and on and on until, presumably, they have no money left. No doubt, the groups that run smart beta strategies would argue they are intended to allow investors to tilt their exposure to factors they believe will deliver strong performance over the longer term. The reality seems to be, however, that that is not how many people use them – choosing instead to churn smart beta ETFs in the hope of squeezing the best possible performance from quarter to quarter. As we never tire of pointing out here on The Value Perspective, nothing in life is certain but, if anything came close, it would be that such a hope is destined to end in disappointment. Ultimately, one of the supposed selling points of smart beta ETFs – the ease with which investors can pick out and trade a particular strategy – is working against them. Instead of tangible companies, complete with management teams, business models and financial statements, ETF investors are buying into ethereal concepts that are based on other people’s definitions of value or momentum, say – and, if one does not work, it is significantly easier to give up and buy an alternative. That of course is the antithesis of what value investors look to do, preferring instead to play the patient, long-term game, with an average holding period of three or five years.

GREK ETF Surging On Hopes Of A Deal

The latest proposals by the Greek government have raised hopes that a deal might be struck soon with the country’s creditors to stop Greece from defaulting on its debt. Greece’s Prime Minister Alexi Tsipras is expected to meet Christine Lagarde, the head of the International Monetary Fund, Mario Draghi, the president of the European Central Bank, and the Dutch finance minister today to finalize the proposals in the agreement. The Greek government has come out with a slew of measures that will focus on fiscal consolidation and tax increases to attain a surplus of 1% this year, followed by 2% and 3% surpluses over the next two years. According to the new proposal, there will be some changes in the VAT structure and the main rate would be fixed at 23%. Also, the corporate tax rate would be increased from 26% to 29% in 2016 and companies will have to pay a surcharge of 12% on profits over €500,000. Additionally, the retirement age would be slowly raised, which is expected to result in savings of €60 million this year. Moreover, workers’ and employers’ contributions to the pension system would also be hiked. The recent euphoria about the deal has led to a rally in Greece stocks and its related ETF. The Greek ETF – Global X FTSE Greece 20 ETF (NYSEARCA: GREK ) – has gained roughly 15% in the past one week. The rally might continue if the deal is indeed sealed and Greece manages to avert its default. Below, we have highlighted the GREK ETF in detail for investors keen on enjoying the Grecian ride. GREK ETF in Focus The ETF tracks the FTSE/ATHEX Custom Capped Index that is designed to reflect the performance of the 20 largest securities listed on the Athens Stock Exchange. The product holds 22 stocks in the basket and is heavily concentrated in the top 5 holdings that make up for a combined 48% of assets. Coca-Cola (NYSE: KO ), Hellenic Telecommunications ( OTCPK:HLTOY ) and National Bank of Greece (NYSE: NBG ) are the top three holdings. Financials dominates the fund with one-fourth assets, followed by Consumer Discretionary with 17.6% and Consumer Staples with 16.6%. The ETF has around $327.1 million in its asset base and sees a moderate trading volume of more than 800,000. The fund charges 55 bps in annual fees from investors and has a dividend yield of 1.17%. GREK currently has a Zacks Rank #4 (Sell) with a High-risk outlook. Bottom Line The condition of Greek banks is worsening by the day and it is almost on the brink of a collapse as savers have lost all confidence and continue to pull out money. In fact, the European Central Bank has sanctioned a release of more than €900 million to Greek banks on Tuesday so as to enable them to remain open. Some economists fear that these austerity measures are not feasible and it might worsen the recession that Greece re-entered last quarter. Lagarde also believes the measures are only a stopgap solution and are inadequate to bring Greece out of the crisis. Original Post