Trading Ideas April 2010: Buying the MSCI Japan and replacing Emerging markets


IDEA of the month:  Buying the MSCI Japan and replacing Emerging markets

This month we buy the MSCI Japan index with 20% weight and sell the MSCI Emerging Market Index. With this move, we buy the weakest performing major equity region since the start of the equity recovery in March 2009…….

and we sell the strongest performing region. With emerging markets we sell a region which is a “consensus call” and with Japan we buy a region which is much less a consensus call. In addition, the MSCI Japan has low Beta of 0.52 relative to the MSCI World and this slightly reduces the risk of our portfolio.

Our Japanese economist has recently upgraded Japan export growth 2010E to a strong 29%, especially due to strong export growth into emerging markets.

Japanese exports to emerging markets are now twice as high as to developed markets. In addition, Japan currently benefits from earnings upgrades, fund inflows and structural improvements in the fields of political decision-making and corporate governance. In 2009 the Democratic Party of Japan took over government from the Liberal Democratic Party (LDP) which had ruled since 1955.

The MSCI Japan also helps to increase the currency diversification in our portfolio. Main risks to buying the MSCI Japan include a general decline of the equity market, a restart of significant earnings downgrades of Japanese companies and the deflation becoming stronger than expected.

With this portfolio change we keep the equity share of our Index portfolio high at 75%. The high equity share has worked well so far as the MSCI World has reached an 18-month high last week. Strong real economic data in the last weeks have supported equity markets. Our economists have pushed the first expected rate hike of the ECB back to March 2011. So equities could continue to do well over the next months if Sovereign risk and Government yields can be contained. Equities remains the most attractive asset class on our scorecard.


“MSCI USA TRN” index 10% weight

Our economists expect an ongoing strong recovery of the US economy. They expect an US GDP growth 2010E of 3.8% compared to 1.1% for the Eurozone. Much of the improvement in the economy has been in the business sector, namely inventories and capital spending; export growth also has been particularly robust. This is evident in key measures of factory activity, such as the National Purchasing Managers’ Index and industrial production.

However, recent strength in retail sales is encouraging and imparts some upside risk to our forecast for consumer spending, especially if the labour market shows more noticeable improvement in the months immediately ahead. Our US equity strategist expects a continuing performance of US equities. He has an S&P500 target 1250 on long-short equity hedge funds and futures positioning unwind by April payrolls (reported first week of May).

Year-end target remains 1325, an upside of 14% from today. The stronger Dollar has supported the performance of this position and going forward our FX strategist expect a flat level of the Euro/Dollar rate at around 1.35 over the next 12 months. Main risks for buying the index “MSCI USA TRN” are a weakening of the US-Dollar, negative news flow from the US economy, major earnings downgrades for US companies and declining US equity markets.


“Stoxx 600 Banks” index 15% weight

We had bought the Stoxx600 Banks sector because in our view the sector could outperform in a recovering overall market over the next few months as many fears have been priced in for the Banks sector in the last 6 months, in our view. One key major negative for Banks have been the plans for stricter regulations/ higher taxations including the US plans to limit proprietary trading and the UK bonus tax. The other key major negative for Banks was the focus on sovereign risk in peripheral European countries (Portugal, Ireland, Greece, Spain) and the significant exposure of European Banks to these countries. In our view, the Banks sector could well continue to outperform the European equity market, if the negative points above come gradually out of the focus. In addition, Banks remains one of the most attractive sectors on the scorecard. Main risk for the Stoxx600 Banks performance is increasing worries on sovereign risk and banks regulations.


“Dax” index 20% weight

We had bought the Dax index in our last issue. In Europe the country view had come into the focus again together with the sovereign risk discussion. This discussion may well continue for some time. Reasons in favour of Germany and the Dax index include low sovereign risk, strong competitiveness position (supported by the low rise in labour costs over the last decade), strong trading surplus and strong Dax earnings growth 2010E and a moderately attractive valuation. Germany as the major country in core Europe could well benefit from ongoing discussions around core vs. peripheral Europe. The weaker Euro should additionally support German exports. Therefore we continue to expect the Dax to outperform in a positive equity market environment. Main risks to buying the Dax include a general decline of the equity market, a restart of significant earnings downgrades of German companies and a slowdown of the Global economic recovery in 2010E.

“Emerging Markets Liquid Eurobond Euro Index” 10% weight

We had bought the “Emerging Markets Liquid Eurobond Euro Index” mainly because of the attractive coupon. We clearly admit that this is a high risk investment. However, the stable economic outlook and ongoing low risk aversion should support EM bond markets in the next months. The two major regional blocks in the “Emerging Markets Liquid Eurobond Euro Index” are Latin America and Emerging Europe. The countries (issuers’) weight is determined based on GDP, GDP per capita, outstanding Eurobond volume and liquidity. The countries with the highest weight in the index are Venezuela, Mexico, Turkey, Brazil, Philippines and Russia.


Trading portfolio

This month we buy the “MSCI Japan TRN Index” with 20% weight and sell “MSCI Emerging markets TRN” with 20% weight. The portfolio targets absolute return and has the EONIA index as benchmark.



Source: Trading Ideas ETF: Ideas and Flows – Deutsche Bank AG

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

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