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Dec 14, 2016

S3 BLACKLIGHT: Longs & Shorts are Post-Election Bears for EEM ETF

At first glance the $27 billion market cap IShares MSCI Emerging markets ETF (EEM US) had a strong year with a year to date return of 12.7% and inflows of $3.3 billion. EEM’s first three quarters were strong with the fund up 16.3% with ETF inflows of $6.7 billion, but since October investors have turned decidedly bearish with long shareholders selling their positions, shorts sellers building up theirs, and the ETF’s stock price down 3.2%.

With short interest is $6.7 billion EEM is the fourth most shorted ETF following the three major market index ETF’s: Spider S&P 500 ETF (SPY US) at $47.0 billion, IShares Russell 2000 ETF (IWM US) at $16.7 billion and the IShares Nasdaq 100 ETF (QQQ US) at $7.1 billion. Short activity in EEM has been very active this year, especially in the 4th quarter, with $1.9 billion of new shorts in November and $1.8 billion of new shorts in December.

A strong US Dollar, an impending Fed Funds rate increase (with possibly more to follow) and President-elect Trump’s “America First” economic policy and trade stance have put a damper on emerging market investments. With over 53% of EEM’s equity allocation in China, South Korea, Taiwan and Hong Kong, there is a high probability that any protectionist policies or tariffs would hit these countries very hard.

After adding more than $6.4 billion of new EEM shares in the 3rd quarter, long holders were net sellers in the 4th quarter reversing more than half of their 3rd quarter inflows by selling $3.5 billion of their EEM positions. Coupled with these sales were almost $3.8 billion of new short sales bringing $7.3 billion of asset sales in just over six weeks. The approximately 200 million shares which were sold by both long holders and short sellers represent almost 10% of average trading volume since November 1st.

But investors were not just selling EEM to generate Alpha or hedge their portfolios; they were also selling EEM’s underlying securities. Of the top ten holdings for EEM, which make up 21.5% of the portfolio, only three stocks are up since November 1st. Samsung Electronics (005930 KS), EEM’s largest holding, was up 7.75% since November 1st along with two Hong Kong Banks, China Construction Bank (939 HK) up 1.41% and ICBC (1398 HK) up 1.93%. The remaining seven stocks were down 6.41% on average since November 1st.

Historically, ETF inflows\outflows and changes in short interest were a good barometer of EEM’s price movement. ETF inflows and decreases in short interest coincided with relative outperformance by EEM in the 1st and 3rd quarters while ETF outflows and increases in short interest coincided with relative underperformance in the 2nd quarter. This synchronicity has held true for the first 6 weeks of the 4th quarter.

This past week EEM’s short interest increased by $1.8 billion, but there were ETF inflows of $81 million. We are at a crossroads where short sellers are still bearish but long holders are becoming more neutral. If EEM’s short interest starts to decline and inflows continue to grow, we may be seeing a confirmation that the emerging market bears from the early 4th quarter are turning into year-end bulls.

For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC     Ihor.Dusaniwsky@S3Partners.net
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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