2018: Liquidity getting tighter, short EM stocks vs. DM stocks

We said:

USD liquidity pressures have eased over the last few months. Financial conditions have stopped tightening, providing some respite for stocks. But somebody forgot to tell EMs: countries with low resilience scores (i.e. large current account deficits and low FX reserves) continue to see outflows. But now liquidity pressures are set to rise again, and financial conditions are at risk of tightening.

EM assets remain vulnerable. In recent weeks, the threat of trade wars has hogged the headlines. But liquidity strains are likely to come to the fore again. Externally vulnerable EM countries (see our recent Global Financial Trends and Daily Note on EM FX reserves) are likely to suffer further losses due to both liquidity and trade risks. We retain our strongly negative stance on EM risk in EM Strategy Monthly, as trade frictions remain intense and Chinese growth is still slowing. This week we add a relative value short MSCI EM / long MSCI DM position to the model portfolio.
 

Outcome:

By 10 October 2018 the trade had made 8% as markets woke up to the reality and effects of trade war and tighter liquidity conditions. We  believed the theme had further to run but introduced a stop-loss to lock in 4% profit. Trade closed off on 21 November 2018 for a profit of 4%. 

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