EPOL: Still Too Early To Buy The Dip (NYSEARCA:EPOL)

Intro and thesis

A few days ago, I published a bearish article about the Global X DAX Germany ETF (DAX). Within a few days, my prediction came true – the still relatively expensive German market (measured by book value) fell 5.93%, while the S&P 500 Index corrected only 0.48% over the same period:

Today, I would like to draw your attention to the iShares MSCI Poland Capped ETF (EPOL), which rose sharply on March 8 and March 9 after a long slide since the beginning of 2022:

Yesterday, European markets showed relative strength – the WIG20 index, the underlying of EPOL, has risen by >3.41% – the same kind of sentiment was observed in all major European markets:

However, my main thesis is that these gains will not last long, and we will most likely see a continuation of the downward movement in the coming days, because the reasons for which the previous correction took place are still relevant, especially for Poland.

Why do I think so?

Poland borders Ukraine and is therefore forced to absorb some of the economic blows from this neighborhood. More than 1.2 million Ukrainian refugees are already in Poland. This is good from an ethical point of view, and the Poles deserve great respect for their help to the victims of this terrible war. However, we must not forget that the more refugees there are, the more economic resources must be spent to accommodate them, even if it is only temporarily.

As Bloomberg reports, numerous gyms, auditoriums, and even shopping malls are being converted into temporary shelters across Poland. Many Poles are willing to take in refugees, which is noble, but will most likely place an additional economic burden on the population, as refugees are unemployed for obvious reasons.

That is, an ordinary Pole will most likely spend less money in absolute terms due to the unfolding war “behind the fence” – add here the devaluation of the national currency (-11.91% against the dollar over the past month), and the negative effect will look even bigger.

Worldwide commodity prices have been rising at an insane pace lately, which must ultimately lead to relatively high inflation in the country – another piece of bad news for Poles’ purchasing power.

The devaluation of the national currency amid such high inflation has prompted the Polish government to force an interest rate hike higher than previously expected – to 3.50%:

Moreover, all the countries around the scene of hostilities were forced to urgently increase their rates:

Yesterday’s sharp drop in oil prices was unprecedented, but crude oil is still too expensive to significantly reduce the pressure on rising food prices in Europe because it is not the only component. The fact that Europe has not yet abandoned Russian gas is certainly a positive factor, but this news does not change the price dynamics for commodities in general – due to the emergency interest rate hike and high prices, industrial production in Poland is seriously threatened, in my view.

Moreover, Russia is one of Poland’s top 5 import and export partners, so retaliatory sanctions by Russia are likely to affect Polish interests first and foremost – especially if the Poles send military equipment to support Ukraine.

In addition, one should be aware that this ETF cannot be called truly diversified – more than 41% of the companies in the fund belong to the financial sector, which in my opinion is an obvious drawback for a “broad market ETF”.

Compare this kind of diversification with (SPY), a broad US exchange-traded fund, to see the difference:

The financial sector in EPOL is represented mainly by commercial banks and insurance companies – PKO Bank Polski (11.17% of the fund), PZU (6.71%), Bank Pekao (6.6%). It is common knowledge that the financial sector has a certain advantage when it comes to interest rate increases. However, this sector, as we have seen recently, has suffered the most from the isolationist measures taken against Russia, when it was decided to cripple the financial sector of the largest country in the world by disconnecting some banks from the SWIFT system. I believe that the isolation of Russia will continue and that the once-close ties between the Polish and Russian economies will continue to put pressure on EPOL.

Devaluation will also have a negative impact on Poland’s banking sector.

That is why I am more bearish than neutral regarding the only Poland ETF – EPOL. At least in the medium term.

Risks to my thesis and takeaway

I may be wrong about the economic impact on Poland of receiving and accommodating such a large number of refugees on its territory – in any case, the Polish government plans to receive EU support for all the costs involved.

The government [Poland] will pay 1,200 zloty a month, for up to two months, to every family that has given shelter to Ukrainian refugees. Morawiecki said he expects to receive financial support from the EU to make up for the budgetary expenses.

Source: Bloomberg

However, the country will be taking the first hit – the EU will not be able to compensate for all the costs, in my opinion.

I could also be wrong about the disadvantageous position of the Polish economy in terms of economic ties with Russia. If Putin does not impose retaliatory sanctions on Polish goods, the economic catastrophe will not occur. And even if retaliatory measures follow, Poland could switch to other partners. The only question is how fast this switch will happen. It will probably take months, and WIG20 and EPOL will not wait that long.

Based on all of the above, I conclude that EPOL will likely continue to fall after the short-term optimistic bounce ends. Institutional investors, as we can see, may agree with my conclusion, continuing to systematically withdraw money from this ETF:

I have opened a SHORT position on EPOL and plan to add more on the next upswing.

Happy investing and stay safe!