Trading Ideas 11 February 2011: Shorting Emerging markets, taking profits on the Dax

IDEA of the month: Shorting Emerging markets, taking profits on the Dax

This month we buy the Emerging market equity short index with 10% weight and take profits on the Dax by selling our 10% stake. With this step we significantly reduce the equity weight of our index portfolio by 20 percentage points from 30% to 10%. The Dax is …….

close to a 3-year high and is close to our 2011 year-end target of 7410. Therefore, the short term risk-return relation has become less attractive, in our view and equities have become less attractive on our score card. We focus the equity positions in our portfolio on European sectors Banks, Utilities and Healthcare and high dividend stocks via the Eurostoxx Select Dividend 30 Index. All three sectors have underperformed in 2010 and have a more attractive valuation /risk profile than the Dax or MSCI Emerging markets. We also keep our Short Food & Beverages, the weakest European sector YTD.

We stick to our commodities position as the strengthening of the US economy and rising Industrial production in China support higher commodity prices. YTD commodities have clearly outperformed EM equities. The long held correlation of commodities to equity and FX markets has recently broken down as the commodity market has shifted focus to physical drivers. We expect supply constraints will play an increasingly important role in driving commodity returns
higher. Therefore, the outperformance trend YTD could well continue and support our relative trade Long commodities vs. Short EM equities, in our view. In particular, higher Food prices triggered by adverse weather conditions in various global regions have a high impact for EM inflation and could become a burden for Emerging market economies and EM equities market. We also stick to our Short IBoxx Euro Sovereign Eurozone TR index as we continue to expect rising interest rates. Our portfolio has posted a performance of 3.1% YTD.

TI 23022011

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rated “BB”. 13% of the basket is rated “B” and this is one issuer, Venezuela. So the country
with the biggest weight in the index is also the country with the lowest rating. While
Venezuela is clearly a high risk country with 13% weight in the index, the remaining countries
are clearly more solid (for more details on the “MSCI USA TRN” ETF see ETF: Ideas and
Flows, 25 November 2009).
“db x-trackers Currency valuation” ETF 20% weight
In currency markets the majority of the participants are “liquidity seekers”. “Profit seekers”
are a minority in currency markets and can generate returns on the expense of the “liquidity
seekers”. Profit-seekers can generate returns by buying “under-valued” currencies and
shorting “over-valued” currencies. A widely used measure to determine “under-valued” and
“over-valued” valuation for currencies is the concept of “Purchasing Power Parity” where
“fair” exchange rates are calculated by comparing the prices of a basket of goods in different
countries. The ETF “db x-trackers Currency valuation” buys each quarter the three currencies
with the “lowest” valuation out of the universe of the G10 currencies and sells the three
currencies with the “highest” valuation using the PPP concept. In addition, the correlation to
equities and bonds is very low and therefore the currency valuation index helps to diversify
our ETF portfolio. The index is currently long in the US Dollar, New Zealand Dollar, and the
British Pound whereas the index is short in the Swiss Franc, Swedish Krona and the
Norwegian Krona. Risks to the investment include that currencies movements become less
rational again. Especially increased uncertainty about the economic development could
trigger a flight back into expensive currencies like the Swiss Franc (for more details on the
“db x-trackers Currency valuation” ETF see ETF: Ideas and Flows,12 June 2009).
Trading portfolio
We have kept the portfolio unchanged this time. Earlier we bought the “Emerging Markets
Liquid Eurobond Euro Index” ETF with 10% weight and sold the “db x-trackers DJ Stoxx
Global Dividend 100 ETF”. The portfolio targets absolute return and has the EONIA index as
benchmark.


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