From the desk of Steve Strazza @Sstrazza
We have been writing a lot about risk-appetite lately as we’re constantly trying to gauge the “animal spirits” at work in the markets. Right now we’re seeing a lack of participation from risk-assets such as Small-Caps, Commodities, and the more cyclical sectors as well as a risk-off theme in many of our intermarket ratios.
We’ve covered the US plenty already, so this post will focus on what we’re seeing from risk-assets in Equity Markets abroad.
This week’s Mystery Chart was an inverted chart of the Frontier Markets ETF (FM). Thanks to everyone for participating. You were pretty much ALL buyers this week, which means you were actually selling Frontier Markets against their prior all-time lows.
Here is a look at the same chart, but uninverted.
Click chart to enlarge view.
Frontier Markets are an Index of the world’s most underdeveloped countries’ stock markets. This would include countries such as Kuwait, Vietnam, Kenya and Nigeria, among others. We often look to Emerging Markets for an indication of risk-appetite. Well, the countries included in Frontier Markets are even riskier as they are deemed too undeveloped to be classified as “emerging.”
Think of Frontier Markets as the Micro-Caps of World Equity Markets. The global “trash trade.” This is where investors go when they are looking to take on as much risk as possible.
So, what is the chart telling us about the level of risk-tolerance among investors right now? It’s definitely not good as the riskiest countries around the globe just broke to fresh record lows during the recent selloff. In our Mystery Chart post, we pointed out the breakaway gap and violent move that followed as momentum hit its most oversold reading on record, confirming the new lows.
While this could certainly be a failed breakdown and prices can whipsaw higher from here, with a strong structural downtrend and risk this well-defined, we’d rather err in the direction of the underlying trend and take a shot on the short side.
Since the fresh record lows made last month price has been consolidating in a bear pennant or rising wedge as it chops around former support turned resistance at its 2016 lows near 22. Here is a zoomed-in look at a daily candlestick chart.
In another post today, we discussed how the weakest areas within US Equities were only able to retrace about 38.2% of their recent drawdowns while the strongest areas have retraced 61.8% or more. What does it say about Frontier Markets that they were only able to retrace about 20%?
Not only does it speak to the risk-averse posture of markets right now, but we think this is an area we can take advantage of on the short side. In a market that is becoming increasingly more bifurcated by the day, we want to continue to bet on the leaders and strongest areas while fading the weakest… and this is definitely one of the latter.
We want to be short Frontier Markets for a quick trade back towards the recent lows as long as prices are below this week’s highs of 22.50. Even though this is only about a 10% move, your risk is very well-defined, offering more than a 3x reward/risk at current prices.
Thanks for reading and please let us know if you have any questions!