If you are extremely bearish on a particular country, you may be wondering how you can short a country. Well, the truth is that there is no simple solution, however, there are a few ways to profit from the economic collapse of a specific country.
In this article, we will go over a few ways that you can use to short a country and the advantages and disadvantages of each one.
Economies move in cycles, and when a boom cycle ends, a downturn is to be expected. Downturns can happen for a number of reasons, and as the stock market reflects how well the economy is doing, they tend to move in tandem.
For that reason, you might be looking for ways to profit from an economic downturn happening in a specific country. How do you go about profiting from this? Let’s look at a few ways you can try to bet against a country’s economy.
A simple way of shorting a country
One of the simplest ways to bet against a country is to short an ETF comprised of stocks from that country. That will give enough short exposure, and if that local stock market crashes you will certainly profit.
You may also choose to buy puts on that ETF, and this might reduce your overall risk.
However, this is a simple way, and therefore it will not provide you with the best returns. Instead, we are going to look at some alternative ways of doing this.
Alternative ways to short a country
One of the most profitable ways to short a country is by picking the worst stocks in that country. This means that not only are you looking to profit from an economic downturn in that region, but you are expecting that these stocks’ performance will be even worse than the ETFs.
You can either short these stocks or buy puts depending on the region. You might even consider selling naked calls depending on your risk tolerance, and how confident you are of your predictions. Just remember that these strategies involve a lot of risk-taking, and should only be carried out by seasoned investors.
In order to do so, you need to start researching companies in that region. Here are a few signs to look for:
- Overleveraged companies
- Companies with declining revenues and profits
- Unprofitable companies
- Companies that rely heavily on the country’s economy
- Overvalued companies
Overleveraged companies tend to be great to bet against. During an economic downturn, they tend to suffer more, since they are unable to repay their debts, as they see their revenues and profits decline.
Companies with high levels of debt will have a lot of challenges in order to raise capital. This puts additional pressure on the company and its stock price.
Declining revenues and profits
Another great of finding stocks is to bet against is by looking for declining revenues and profits. A company that is struggling and seeing its financial performance deteriorate is usually a great short during a downturn. The market tends to sell these types of companies faster, as the capital moves to safer options.
Unprofitable companies also tend to be great short ideas, during an economic downturn. As capital tends to be deployed to higher-quality companies, these companies may struggle to raise funds and even compete.
Companies that rely on the economy
Some companies are deeply affected by economic downturns, as consumer preferences and behavior tend to change during these economic cycles. For instance, auto companies tend to suffer, as consumers avoid getting a new car. This type of business has a very strong positive correlation with the country’s economy, and are ideal investment vehicles to short a country.
Lastly, we have overvalued companies, that tend to see multiple contractions and reduced valuations during an economic downturn. As analysts' estimates are revised, and growth slows down, their valuations are bound to decline.
Overvalued stocks are therefore more likely to suffer bigger drawdowns than the broader market.
Combination of factors
You may even look for companies that combine these different factors, and these usually tend to be the best shorts. The idea is that these stocks will underperform the broader market, and therefore shorting them is more profitable than shorting an ETF or the main index.
Another great idea is to look for small caps stocks since on average they tend to be more volatile. If there is an economic downturn, small caps are expected to lose more of their value.
Finally, you may also consider shorting stocks that are very dependent on that economic region. If there is an economic downturn in a certain country, there are several companies with operations in that area of the globe. These are usually great short ideas. Look for companies that are very dependent on that region, and whose revenues come from there.
As we have seen there are several different ways of shorting a country. Remember that you should be aware of the risks of shorting, and if you are not totally comfortable with the risks involved it is better to avoid it or keep your short position fairly small.