EWT - EWT ETF: Not Very Compelling At This Juncture

2023-10-02 15:19:35 ET

Summary

• iShares MSCI Taiwan ETF has delivered double-digit returns in a year where Asian emerging market stocks have performed poorly.
• External trade which accounts for 118% of GDP has been impacted by weak export conditions for a year, although things could pick up in Q4.
• The government intends to step up support for domestic players in the IC chain, but uncertainties surrounding biggie Taiwan Semiconductor's outlook could leave an adverse mark.
• Valuations are not cheap, and the price imprints on the standalone chart reflect the strength of the bears.

Introduction

The iShares MSCI Taiwan ETF ( EWT ), is a 23-year-old exchange-traded fund, or ETF, with over $3bn in assets under management ("AUM"), that offers exposure to around 100 Taiwanese-based stocks. In a year where Asian emerging market stocks (as represented by the iShares MSCI Emerging Markets ETF-EEMA) have gone nowhere, EWT has done reasonably well, delivering double-digit returns.

Could the ETF continue to showcase similar returns in the months ahead? Well, here are a few important themes that could weigh on the ETF's performance

Key Themes

External trade is a vital fulcrum of the Taiwanese economy, accounting for over 118% of nominal GDP, but this is something that continues to be in the doldrums. The lifting of policy rates across key consumer markets across the globe has dampened demand for consumer electronics, which in turn has put a spanner in the works of Taiwanese exports. This has been going on for 12 straight months, and the most recent report pointed to a massive decline of -16% YoY, over 500bps worse off than what the street was expecting.

On account of this lingering weakness, federal agencies have been forced to bring down the overall GDP rate for FY23 from 2.04% to 1.61% .

Now, however, with the weak base effect on the anvil (in November/December 2022, exports were down significantly by double-digits), one could perhaps hope for positive export growth soon enough. Also, given an overall expected export YoY decline of 9.5% for the whole year (Source: Directorate General of Budget, Accounting and Statistics), it would imply some positive growth in Q4-23.

Investors can perhaps also be encouraged by the news coming out from Taiwan suggesting that NT$ 12 billion of funds (over 5 years) could be funneled into helping Taiwanese IC designers become more competitive in an era where AI and communication technology ramps up across the globe.

Even otherwise, from next year, Taiwan, which has strong linkages with the semiconductor industry (it supplies around 60% of the globe's semiconductor chips), should receive a fillip as global semiconductor sales are expected to grow by 12% . It's also worth noting that next year's GDP growth forecast will likely be twice as much as this year, with an expected rate of 3.3% (Source: Directorate General of Budget, Accounting and Statistics).

Having said all that, investors should pay particular importance to developments with the Taiwan Semiconductor ( TSM ) stock, which enjoys an inordinately large stake in this portfolio (21%). Currently, things are not in a good way, with the company witnessing a double-digit decline in its sales, and also suggesting a similar cadence for the FY.

The company is also currently grappling with a lot of uncertainty regarding specialist talent shortage for its Arizona plant, and delays regarding the production of accelerators used in HPC and AI applications. Until there's greater clarity on these issues, the TSM stock may struggle to generate outsized gains, even though a lot of investors expect it to play a key role in the proliferation of multi-year trends such as 5G and high-performance computing.

Closing Thoughts - Valuation and Technical Considerations

We're also not necessarily convinced that iShares MSCI Taiwan ETF offers decent value at current levels; with 60% of the portfolio coming from the tech sector, one wouldn't expect EWT to be priced like a value-based ETF, but yet still, you'd also want to see a decent level of long-term earnings growth for that multiple, and that isn't something you're likely to get.

For further clarity, note that EWT is currently priced at a P/E of 17x , which translates to a 16% premium over the corresponding multiple of the iShares MSCI Emerging Markets Asia ETF ( EEMA ). Crucially, at 17x P/E one is likely to only get high-single-digit long-term earnings growth, whereas with the less exorbitant- EEMA, one could likely get better earnings growth potential of 11% .

These dynamics are also reflected on the relative strength charts, which measure the strength of EWT as a function of EEMA. The relative strength chart can be useful in identifying potential pivot points to exploit a mean-reversion trade. For instance, if EWT was trading at rather lowly levels relative to EEMA, one could've raised the probability of rotation interest towards EWT, but rather, what we have in reality is something else with the current relative strength ratio perched close to the top-end of the long-term range.

On EWT's standalone weekly chart, it's evident that bearish undertones have taken over of late. In December last year, we saw a massive red-bodied candle, and with almost 10 months on the clock, one would've hoped for EWT to negate this weakness.

What we can see is that there were decent attempts to trend up in the shape of an ascending channel, but that came to an end in August, with the price breaking down below the lower boundary of the channel. After the breakdown, EWT has not been able to recoup the old channel but rather continues to drift. If one takes a bird's eye view, the long-term price imprints are more akin to a bearish flag pattern . Until one witnesses some bottom formation in the price action, we wouldn't advise a position in iShares MSCI Taiwan ETF.

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