Emerging-Markets Puts Jump With QE End Looming: OptionsInyoung Hwang and Namitha Jagadeesh
China’s weakening growth prospects and the imminent end of Federal Reserve stimulus are spurring traders to scoop up protection on emerging-market stocks.
The cost of bearish options on the iShares MSCI Emerging Markets ETF rose to the highest level in more than a year relative to bullish wagers last week, data compiled by Bloomberg showed. Investors are paying up to hedge after pouring $6.1 billion into the exchange-traded fund in the past four months and following the fund’s rally to its highest price since May 2013.
While economies from Mexico to South Korea are growing, emerging-market shares have still struggled to outperform their peers in developed markets, according to Peter Dixon, global equities economist at Commerzbank AG. With the Fed on track to complete its quantitative-easing program by the end of this year and forecasts for the slowest Chinese economic growth in 24 years, emerging-market shares may not rally much further, he said.
“You’d like to think this is the time for emerging markets, but how many times have we said that in the last three years?” Dixon said by telephone from London. “Investors may be moving some funds back into these markets. But investors will come back cautiously. They want to see to what extent the recent turnaround is real.”
Options pricing in a 5 percent decline in the emerging-markets ETF on June 23 cost 4.6 points more than wagers betting on a 5 percent increase, according to three-month implied- volatility data compiled by Bloomberg.
The last time the relationship, known as skew, was this high was after former Fed Chairman Ben S. Bernanke signaled on May 22, 2013 that the U.S. central bank may scale back its bond-buying program, fueling investor concern that tapering stimulus would reduce capital flows to emerging economies.
Emerging-market stocks benefited as the Fed kept interest rates at a record low since 2008 and embarked on three rounds of stimulus. The MSCI Emerging Markets Index rallied 121 percent from March 2009 until Bernanke spoke last May, outpacing the 113 percent gain in the MSCI World index.
Last month, the central bank trimmed bond buying by $10 billion for a fifth straight meeting, to $35 billion, keeping it on pace to end the program late this year.
The MSCI Emerging Markets Index has risen 1.4 percent since May 22, 2013 compared with the MSCI World Index’s 17 percent gain in the same period. Losses in developing-market stocks extended in January after Argentina devalued the peso and the Turkish lira tumbled.
While investments over the past four months have boosted the EEM after it lost $16.3 billion between January 2013 and February this year, it’s unclear whether the poor performance of emerging-market equities is over, according to Dixon.
Of the 10 most-owned contracts on EEM, eight were bearish. Puts betting on a decline to $41 a share by July 19 had the highest ownership, followed by options wagering on a drop to $39 over the same period, data compiled by Bloomberg show. Traders owned more bearish options than bullish ones, holding 4.2 million puts on July 2, compared with 2.9 million calls, according to the data.
Samsung Electronics Co., China Construction Bank Corp. and Gazprom OAO are among the top 10 holdings in the fund, according to the iShares website. The stocks ETF is most exposed to China with a 17 percent allocation, followed by South Korea and Taiwan.
Economists predict the Chinese economy will expand 7.4 percent this year, the slowest rate since 1990, and that growth will slow to 7.2 percent in 2015.
Still, China’s stock market usually gains in the second half of the year as the ruling Communist Party takes steps to meet economic growth targets, according to RBC Investment Management (Asia) Ltd. Premier Li Keqiang last month pledged to ensure a minimum growth rate of 7.5 percent this year.
The government has already eased lending restrictions and accelerated state spending plans to counter a property-market slump, helping spur a 14 percent rebound in the country’s Hang Seng China Enterprises Index from an eight-month low on March 20 through yesterday.
Short interest on EEM has fallen to 2.8 percent of shares outstanding after reaching a more than five-year high of 18 percent in March, data compiled by research firm Markit show.
Stocks in the MSCI emerging-markets gauge are trading at 11.7 times estimated earnings, lower than the multiples of 15.7 for the Stoxx Europe 600 Price Index and 16.8 for the Standard & Poor’s 500 Index, according to data compiled by Bloomberg.
“Compelling valuations provide a safety net for emerging-market stocks against further Fed tapering,” Didier Duret, who helps oversee 171 billion euros ($233 billion) as chief investment officer at ABN Amro Private Banking in Amsterdam, said by phone. “We’ll see an economic uplift in China in the coming months. We’ll see it in exports and manufacturing data.”
Elections this year in India, Indonesia and Brazil are also positive for stock investors, according to Duret. India’s S&P BSE Sensex has advanced 8 percent since Prime Minister Narendra Modi’s election win amid optimism his government’s mandate will bolster growth.
In Indonesia, Jakarta Governor Joko Widodo, who has pledged to improve regulations to attract investments, is leading polls before a July 9 election, according to a Roy Morgan survey in June. In Brazil, Prime Minister Dilma Rousseff’s support among voters has risen to 38 percent, according to a Datafolha poll this month. The vote is scheduled for Oct. 5.
The Chicago Board Options Exchange Emerging Markets ETF Volatility Index fell to 13.71, its lowest in more than three years. The CBOE Volatility Index, the gauge of S&P 500 options prices known as the VIX, declined 4.6 percent to 10.32 yesterday, the lowest since February 2007. Its European counterpart, the VStoxx Index, was little changed at 12.88 at 9:57 a.m. London time today.
While there has been some stabilization in Chinese trade data, investors are still positioned cautiously, according to Patrick Moonen, who helps oversee $241 billion as a senior strategist at ING Investment Management. China’s exports rose 7 percent in May from a year earlier, data last month showed.
“We are still worried about the fundamental trends in the Chinese economy due to high debt levels, slowing growth, and stress in the real-estate market,” Moonen said in an interview from The Hague.