Weekly Investment Insights – Correction presents buying opportunity
In 2017, ETF Securities will be broadening its weekly FX insights to cover all asset classes including commodities, equities and fixed income. We hope you continue to find these updates useful.
Highlights
Optimism over growth prospects and accommodative monetary conditions have pushed European equity benchmarks to multi-month highs.
Current levels look unsustainable in the short run as momentum wanes and bearish technical signals surface.
Longer term prospects for European stocks appear more favourable, so any correction could be an opportunity for entry.
Near term top
European equity indices have been a beneficiary of the broad-based optimism that has characterised the market landscape since Trump’s election back in November. Most have recently set multi-month, if not multi-year, highs as analyst earnings forecasts have jumped on the back of an improved outlook for global growth based on reflationary trends. In addition, higher commodity prices, improved net interest margins and ongoing monetary stimulus have also helped to lift beleaguered resource and financial industry sectors that have previously weighed on performance. However, technical indicators suggest that across the board, the recent rally is losing steam, leaving indices such as the EURO STOXX 50, DAX 30, CAC 40 and the FTSE MIB vulnerable to a near term correction. Over the longer term, we believe that the stocks of core European states will remain attractively valued, especially when compared to their US counterparts, making any upcoming correction an excellent medium term opportunity to gain long exposure. This is especially true as economic indicators in Europe gather pace and continue to tick higher.
Momentum wanes
A “toppish” momentum divergence is where a particular index moves higher while its momentum indicators simultaneously trend lower and is typically interpreted as a bearish signal that a rally is coming to an end. This signal is in play for the EURO STOXX 50, DAX 30,CAC 40 and the FTSE MIB. All of these indices have recently reached highs which they have all failed to defend while their momentum indicators have turned lower. This implies that, at least in the near term, these benchmarks will come under pressure or at least remain subdued.
Eurozone economic uptick
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Long term promise
In the medium term, we do not believe that any bearish pressure will last, as positive economic performance in Europe helps provide a boost to stock market performance. Barometers of economic strength, such as GDP growth, manufacturing surveys and industrial production, have all picked up markedly for the Eurozone since Q4 of last year (see Figure 1). The latest manufacturing purchasing managers index reading for January recently came in at the highest level in over five years, pointing towards a sustained recovery for a region that has experienced an uninspiring rebound from the financial crisis. Furthermore, indications from the latest European Central Bank meeting suggest that monetary conditions are likely to remain accommodative for the foreseeable future as core inflationary pressures remain fragile, removing the likelihood of a near term policy shock. Combined with far more favourable cyclically adjusted valuation metrics (specifically cyclically adjusted price to earnings) than the US, European benchmarks looked well placed to move higher in the coming six months.
Investors wishing to express the investment views outlined above may consider using the following ETF Securities ETPs:
Equity ETPs3x
ETFS 3x Daily Long Euro Stoxx 50 (EU3L)
ETFS 3x Daily Short Euro Stoxx 50 (UES3)
ETFS 3x Daily Long CAC 40 (FR3L)
ETFS 3x Daily Short CAC 40 (FR3S)
ETFS 3x Daily Long DAX 30 (GY3L)
ETFS 3x Daily Short DAX 30 (GY3S)
ETFS 3x Daily Long FTSE MIB (IT3L)
ETFS 3x Daily Short FTSE MIB (IT3S)
ETFS 3x Daily Long FTSE 100 (UK3L)
ETFS 3x Daily Short FTSE 100 (UK3S)
2x
ETFS DAX® Daily 2x Long GO UCITS ETF (DEL2)
ETFS DAX® Daily 2x Short GO UCITS ETF (DES2)
ETFS FTSE 100® Leveraged (Daily 2x) GO UCITS ETF (LUK2)
ETFS FTSE 100® Super Short Strategy (Daily 2x) GO UCITS ETF (SUK2)
The complete ETF Securities product list can be found here.
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ECB’s minutes reveal concerns over Eurozone bonds scarcity
ECB’s minutes reveal concerns over Eurozone bonds scarcity. The minutes of the ECB’s December meeting, published yesterday, revealed that the increasing scarcity of high quality government bonds such as German bunds, was at the centre of the two main decisions taken by the Governing Council. Overall, the ongoing deleveraging of the public and the private sectors, coupled with the ECB’s purchases and the elevated demand for high quality Eurozone government bonds have aggravated the shortage of supply. We believe that this is a warning signal that QE in its current form has reached its practical limit in Europe. While some Eurozone governments have procrastinated in using fiscal stimulus, they will soon no longer have the choice but to implement structural reforms to support the economic recovery. Consequently, we believe the rotation from monetary to fiscal stimulus has not been fully priced into the market yet. Thus, we expect Eurozone yield curves to gradually steepen in 2017. Regarding the extension of the Asset Purchase Programme (APP), the minutes revealed that Governors debated over two options: a 6-month extension at a constant monthly pace of EUR80bn and a 9-month extension at a slower pace of EUR60bn. While the first option would have resulted in a smaller total amount of additional purchases (EUR480bn against EUR540bn for the second option), liquidity-related challenges drove the discussion toward the latter option. The first option would have necessitated an additional modification of the parameters of the programme, namely a change in the capital key – the proportion of bonds the ECB can buy from each country defined as the capital participation of the country to the ECB balance sheet. The ECB’s APP has supported bond valuations and reduced the supply of high quality bonds, making government collateral more expensive, leading daily volumes and rates in the European repo market to decline. In order to reduce these unintended consequences on the repo market, the ECB provides a securities lending programme (SLP) where the holdings of securities purchased under the Public Sector Purchase Programme are available for securities lending. The minutes revealed that the relaxation of the conditions to borrow collateral from the SLP was primarily to address the increasing scarcity of high quality bonds and collateral. Accordingly, ECB’s Governors announced in December that cash would be accepted as collateral against securities (no longer exclusively high quality bonds). Despite the marginal revisions of the parameters of the QE to smooth its implementation, the ECB’s monetary stimulus seems close to its practical limit, suggesting the Eurozone yields have reached their floor.
Morgane Delledonne, Fixed Income Strategist at ETF Securities
Morgane Delledonne, Fixed Income Strategist at ETF Securities
Morgane Delledonne joined ETF Securities as Fixed Income Strategist in 2016. Morgane has an extensive experience in Monetary policy, Fixed Income Markets and Macroeconomics gained at the French Treasury’s Office in Washington DC and most recently in her role as Macroeconomist and Strategist at Pictet&Cie in Geneva. Morgane holds a Bachelor of Applied Mathematics from the University of Nice Sophia Antipolis (France), a Master of Economics and Finance Engineering and a Master of Economic Diagnosis from the University of Paris Dauphine (France).
Limited prospect for Eurozone bond gains amid political uncertainty
ETF Securities – Limited prospect for Eurozone bond gains amid political uncertainty
Highlights
The rise of populism in the Eurozone could weigh on the ECB’s Staff forecasts and force the ECB to extend its asset purchase programme (APP) beyond March 2017 at its December meeting.
Countries with the highest level of political uncertainty – France, Austria and Italy – have been hit the strongest by the global bond rout since September.
We believe the ECB could ultimately opt for yield-targeting if political uncertainty markedly alters the financial conditions in the Eurozone.
ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E info@etfsecurities.com
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The analyses in the above tables are purely for information purposes. They do not reflect the performance of any ETF Securities’ products . The futures and roll returns are not necessarily investable.
General
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This communication is only targeted at qualified or professional investors.
The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.
This document is not, and under no circumstances is to be construed as, an advertisement or any other step in furtherance of a public offering of shares or securities in the United States or any province or territory thereof. Neither this document nor any copy hereof should be taken, transmitted or distributed (directly or indirectly) into the United States.
This communication may contain independent market commentary prepared by ETFS UK based on publicly available information. Although ETFS UK endeavours to ensure the accuracy of the content in this communication, ETFS UK does not warrant or guarantee its accuracy or correctness. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data. Where ETFS UK has expressed its own opinions related to product or market activity, these views may change. Neither ETFS UK, nor any affiliate, nor any of their respective, officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents.
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Negative rates: The ECB’s policy isn’t working. The European Central Bank’s (ECB’s) policy to give a boost to the Eurozone economy via QE appears to be lacking teeth. What will the ECB do next?The central bank’s QE policy is supposed to stimulate economic activity and ease financial conditions. The problem is that financial conditions have deteriorated in the Eurozone and economic activity is lacklustre. While the ECB’s balance sheet has once again begun to rise, overall Eurozone lending remains stagnant. Lending volumes have broadly tracked moves in the money supply (M3), which have trended sideways in recent years.
(Click to enlarge)
Are negative rates good for banks?
The banking sector has been one of the worst performers across European equity benchmarks. Clearly such a situation of stagnant loan growth does not help bank balance sheets, but negative rates do not appear to be the cause. In aggregate, deposit and lending rates appear to have been declining broadly in line with each other, keeping margins relatively stable. While negative rates don’t appear to be hurting bank deposits, they are certainly not generating much, if any improvement in loan growth.
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What will the ECB do next?
At some point, moving negative rates will either force banks to lend to increasing risky borrowers or enforce negative rates on its customers (potentially causing depositor flight). In an uncertain economic environment, neither choice is very palatable for banks. This leaves the option of pushing rates further into negative territory as one that has limited gains. However, if as the ECB suggest, it is still willing to do whatever it takes, it should perhaps be the bank that lends to riskier borrowers. i.e. expand the mandate of its asset purchase scheme to lower quality issuers as other central banks have to kick-start the monetary transmission mechanism. Anything short of such drastic action amidst the current market volatility is likely to leave the market disappointed. Such disappointment could also unwind some of the ‘easy’ competitiveness gains that a weaker Euro has provided.
Martin Arnold, Global FX & Commodity Strategist at ETF Securities
Martin Arnold joined ETF Securities as a research analyst in 2009 and was promoted to Global FX & Commodity Strategist in 2014. Martin has a wealth of experience in strategy and economics with his most recent role formulating an FX strategy at an independent research consultancy. Martin has a strong background in macroeconomics and financial analysis – gained both at the Reserve Bank of Australia and in the private commercial banking sector – and experience covering a range of asset classes including equities and bonds. Martin holds a Bachelor of Economics from the University of New South Wales (Australia), a Master of Commerce from the University of Wollongong (Australia) and attained a Graduate Diploma of Applied Finance and Investment from the Securities Institute of Australia.
Will oil rally in 2016? Capital markets started the year against a backdrop of a strong rise in risk aversion. Over the last few weeks, fears concerning the health of the US economy, the future of Chinese growth and the collapse in oil prices have pushed investors to protect portfolios and continuously sell risky assets.
The price per barrel is suffering from weak global trade and Iran’s return to the group of oil-producing countries, but also from the particularly mild climate since the end of last year. Accordingly, financial markets are reducing risk, taking this fall in the oil price as the self-fulfilling prophecy of a sluggish global economy lacking momentum. Strong correlation is thus building between equities (including those in the eurozone) and energy commodity prices.
Chart 1 Correlation between equity and energy commodity
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Clearly there are devastating consequences for oil-producing countries, as they watch revenue collapse and face investors withdrawing capital in anticipation of lower rates, on the grounds that emerging central banks will have to introduce more accommodative policies to support the clear slowdown in local activity. Here, too, the correlation between emerging market currencies and the price of Brent is increasing, with each additional fall in oil prices translating into a stronger US dollar versus emerging currencies.
Chart 2 Brent & dollar vs. emerging currencies
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Chart 3 Currencies: US Dollar vs. Euro & emerging currencies
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On the stock market this continuous fall in emerging currencies is penalizing equities for which performance depends, to a large extent, on the change in parity versus developed market equities. In fact, the deterioration in current account balances in emerging countries is creating economic difficulties for regions watching the price of their dollar imports rising constantly. The dollar is no longer rising versus the euro but continues to rise versus emerging currencies, which shows that the later are indeed weakening.
Chart 4 Brent spot price & US rig count
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Is there any hope of an end to this phenomenon this year? We believe that oil may have bottomed out, or that even if it falls a bit further, there is light at the end of the tunnel. In fact, Saudi Arabia’s strategy to undermine US shale oil is working. Even if this industry will not disappear thanks to its high flexibility (the rig count is declining [see chart] but deep offshore drilling is under greater threat at these price levels), US banks may demand a higher cost of capital (defaults should at least rise towards 6% in the US high yield energy segment this year) and the regulator may require a more conservative valuation of reserves in the business models of alternative producers.
From here on in, voices has already raised to this effect. Concerted action could resume within OPEC in order to get better control of production. Indeed, at these prices, several countries will be tempted to buy social peace by rebalancing their budgets with an income boost.
So we can start to think about implementing investment strategies for this new situation. Directly purchasing commodities is not the only option. For an indirect play, energy sectors in US and European majors could be considered, break-even inflation points are at their lowest in the US today and could benefit from tensions with a barrel price which will initially return to around $40. Similarly, developed currencies linked to oil, such as the Canadian dollar (see chart), may also offer the opportunity to play this theme of the end of a great bear cycle for energy.
Chart 5 Brent price & Canadian dollar (vs. $)
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