- Stumbling along the past 6 months, the Direxion Emerging Markets Bull 3X Shares ETF has finally found its enthusiasts, taking off - up 38% in just the past month.
- EDC tracks the MSCI Emerging Markets Index, an index that captures large- and mid-cap representation across 23 emerging markets countries covering some 85% of their market capitalizations.
- Improved prospects for crude oil prices may benefit Brazil and Russia. India is making strong gains, and European Union difficulties may be receding.
- What would market-makers pay? What have their prior forecasts like today produced as price changes in months following?
How to make an intelligent EDC price judgment
First, know what the Direxion Emerging Markets Bull 3X Shares ETF (NYSEARCA:EDC ) is intended to mimic. It is designed to track the economic circumstances in 23 countries around the world, as evidenced by the stocks of over 800 constituents, monitored daily by an index constructed by a Morgan Stanley (NYSE:MS ) subsidiary MSCI, Inc. (NYSE:MSCI ). The ETF is invested in a collection of swaps contracts based on the index.
Neither you nor I nor any one person has much chance to develop an insight into how that index is likely to move in the near or distant future. An ETF geared up by derivatives to have its prices move at a rate three times the moves in the index defies any sensible, reliable price forecast by individual investors.
Any worthwhile, credible guidance needs to come from well-informed, extensively-resourced (trained staffs, local world-wide sources, continual communications systems, experienced economic evaluators), well-capitalized, and highly-motivated advisors. Without such, any prospects we might develop would likely be fragmentary, fragile speculations.
Instead, we can learn what coming-price conclusions such well-resourced and highly-motivated organizations are forced to come to, as they pursue their own objectives and risk defenses.
Those conclusions are revealed by the capital-protecting hedging actions undertaken by the market-making [MM] community, as they make possible the volume transactions in EDC desired by their big-money fund clientele. Their earlier price expectations are available from similar actions and become a means of evaluating how reliable the current forecasts may be, based on how well those earlier forecasts worked out in actual subsequent market performances.
The nature of MM forecasts
What MMs are willing to pay for hedging protections and the way that deals are structured tell how far that community believes that subject prices might be made to travel in coming markets. So the expectations take the form of potential future price ranges, usually surrounding the current market quote. A key characteristic of that price range is the balance between prospective upside and downside potential moves.
We calculate that balance daily and simplify its character by a measure called the Range Index [RI], which tells what percentage of the whole range is below the market quote at the time of the forecast. A RI of 25 indicates that there is 3 times as much upside as downside.
The simplest evidence of MM forecasting ability is to look at
all past forecasts, rank them by Range Index, and observe how prices change in equal time periods after each forecast. Here is how that looks for EDC, in Figure 1.
The number of forecasts involved in each row are indicated by the "#BUYS" column, beginning at the blue row average of 1130 (about 4 ½ years of market days). It shows that EDC in this period (10/8/2010 to present) averaged a -7% price decline over 16 weeks, or 80 market days.
The forecasts are fairly evenly matched in number with Range Indexes above and below the 40 RI blue row, with 538 RIs below 38, and 510 above 40. At the table's upper extreme, there were 338 forecasts with RIs less than 29, which were followed by prices increasing on average by +8% in the ensuing 16 weeks.
At the other extreme, there were 231 forecasts with RIs above 49, where prices subsequently declined -18% on average during the following 16 weeks, or nearly 4 months. All of the price change averages for RIs greater than 38 were negative.
The significance of the magenta number 438 in row RI>43 is that this is the current RI forecast for EDC, with an average price change experience of -18% losses during the next 80 market days. Further details, not shown, reveal that by the 16th week, 3/4ths of the prices starting these forecasts were at a loss, with the worst cases ranging from -45% to -68%.
This history makes it pretty clear that the right price at which to buy EDC is a price which allows a competent forecaster to see no more than 38% of EDC's likely future price range to be below the current price. Better yet, a forecast with 70% of its range above the market quote would offer even stronger prospects for a price gain in an EDC investment.
What's the answer to the article's question as to the price to pay now - if anything? For now, the answer - is nothing - but wait for a better opportunity. Figure 2 shows how that Range Index has changed through recent times, providing attractive capital gain opportunities.
The MM's advice is to pick a good time to invest in EDC, just not now after it has been run up. Better opportunities will come, as suggested in the price range days in green. Just be ready when they do, and be prepared to take profits when the price gets above the top of the forecast triggering the buy. Meanwhile, look elsewhere for better ways to make your capital productive.
(used with permission)
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More. ) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.