EWT: Inventory Correction Creates A Good Opportunity To Invest

Introduction

The recent global inventory correction has impacted Taiwan's economy negatively as a large portion of the country’s economic activities is related to manufacturing. Together with a hawkish Federal Reserve, the country’s stock market has underperformed in 2022. Will this trend continue in 2023 or will a recovery occur instead? In this article, we will analyze iShares MSCI Taiwan Capped ETF (NYSEARCA:EWT) and provide our investment strategy.

ETF Overview

EWT invests in Taiwanese stocks and has a high exposure to technology sector. As a result of its high exposure to technology sector, its fund price is much volatile than the S&P 500 index and has higher downside risk. Many stocks in EWT’s portfolio have struggled throughout 2022 due to inventory correction. However, we may be near the end of this inventory correction cycle. Hence, investors should use this opportunity to accumulate shares of EWT and average down on any fund price weakness.

Fund Analysis

EWT has not done well since 2022

EWT has outperformed the broader market during the pandemic thanks to its high exposure to technology sector. However, its fortune quickly reversed in early 2022. As the economy reopened in late 2021, the demand for technology products diminished and many technology manufacturers were faced with inventory problems. A hawkish Federal Reserve to fight against inflation also caused global equities to fall throughout much of 2022. EWT was also impacted negatively. As can be seen from the chart below, EWT’s fund price declined by nearly 36% since the beginning of 2022. In contrast, the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 index, only declined by about 19%.

Higher downside risk than the S&P 500 index

EWT’s underperformance to the S&P 500 index last year was not unusual. In fact, during the Great Recession in 2008/2009, EWT’s fund price also had a larger magnitude of decline than the S&P 500 index. As can be seen from the chart below, EWT’s fund price declined more than 65% during the Great Recession. On the other hand, the S&P 500’s decline was less than 60%.

There are several reasons why EWT tend to have higher volatility than the S&P 500 index especially in a bear market. First, EWT has a higher exposure to technology sector. In fact, technology sector represents about 58.32% of its total portfolio. In contrast, S&P 500 index’s exposure was only about 25%. As we know, technology stocks tend to trade at lofty valuations in a bull market. Therefore, they tend to decline more in a bear market.

Second, money tend to flow from emerging markets to the U.S. to seek shelter during any crisis (e.g. the Great Recession) as U.S. dollar is perceived as a safer currency than other foreign currencies. Not only will money flow from other foreign markets back to the U.S. during the time of crisis, but money will also flow back to the U.S. when the Federal Reserve shifts their monetary policy towards tightening. This explains why EWT suffered a much greater loss than the S&P 500 index since the beginning of 2022.

Business indicator is now the lowest since 2002 and 2008/2009

As mentioned earlier, many firms in EWT’s portfolio had to face with inventory correction in much of 2022. While it may be too early to declare that inventory correction is over, we can take a look at several economic indicators to gauge the strength of the economy. The first indicator we will take a look is called “Business Indicator.” It is not a forward indicator, but an indicator that reflects the current status of the economy. As can be seen from the chart below, the total score of the Business Indicator in February was the lowest we have seen since the Great Recession in 2008/2009.

February’s Manufacturing PMI data is encouraging

We will now look at another indicator, Taiwan's manufacturing PMI. This is a forward indicator of the economy. As can be seen from the chart below, February's manufacturing PMI was quite encouraging. It rebounded strongly from the cyclical low reached in January. As a result, the manufacturing PMI is now above 50. For reader's information, a value over 50 is an indication that the economy is strengthening. Perhaps, the inventory correction may be near the end.

Investment strategy in 2023

So, how shall we invest in EWT? We think the best approach is to start accumulating shares now. Although we do not know exactly when the stock market will rebound, we know that we may be near the end of this inventory correction based on February's manufacturing PMI. You should be prepared to average down on any fund price weakness. We believe economic activities in Taiwan should strengthen soon and we will eventually see EWT’s fund price rebound meaningfully.

Investor Takeaway

An inventory correction that started about 1 year ago is likely near the end and we think it is a good time to start accumulating shares of EWT. Investors should be prepared to average down the cost especially on any fund price weakness.