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Trading Ideas January 2010: Staying the course with high equity weight

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IDEA of the month: Staying the course with high equity weight

The risk appetite of investors is rising. So, in the last weeks all risky asset classes benefited strongly, while bond markets suffered from the rising risk appetite. Obviously the ongoing low central bank rates and ample money supply have supported equities and commodities. Within the equity space emerging markets outperformed other markets. Although emerging markets lost attractiveness in our scorecards, we stick to our investment in emerging markets, as…….

here the growth outlook is still promising in our view. The same is true for the US economy. We expect a considerable acceleration in GDP growth and a slow adjustment of the central bank policy. This should support the US equity markets in the course of 2010.

Additionally we expect an appreciation of the US Dollar, which makes the US stock market even more attractive in our view. Ongoing discussions about fiscal deficits in the US, Japan and Europe are a burden for the government bond markets. However, other fundamental variables like inflation and central bank policy are still supportive. Thus, we do not expect an ongoing sell-of in this asset class; rather we stick to our flattening position, which we have established in autumn last year. Overall, we stick to our current positioning with a high equity weight of 40%, as we expect a continuation of the strong performance in stocks and emerging markets. The high equity weight is also supported by the scorecards  In our view this favourable environment for risky asset classes could remain in the next months, as central banks indicate a smooth start of possible exit strategies.

Scorecard Asset classes
According to our Asset class Scorecard equities is clearly the most attractive asset class with a score of +5 whereas the scores for Fixed income and FX are only slightly positive. At least the Fixed income has clearly improved over the last three months from a clear negative score into slightly positive territory. Commodities has a neutral score.

Scorecard Equities
According to our equity Region Scorecard Europe is the most favoured region, supported by macro score, attractive valuation and momentum. In contrast, Latin America enjoys the least support due to its expensive valuation and weak macro fundamentals. According to our scorecard for European sectors, Insurance and Technology look the most attractive, while Basic Resourced and Food & Beverage are the least favoured. At the European country level, our scorecards favour Austria and Italy over Germany. Scorecards Fixed income , commodities and Forex

In the Fixed income segment, our scorecard supports the longer maturity bond classes while Global Sovereign Inflation linked bond looks the least attractive. According to our Commodity Scorecard, the Energy group covering Crude Oil, Heating Oil, and Natural Gas is the most attractive while platinum and corn find the least favour. Our FX Scorecard is positively tilted towards the British Pound and is negative on the Swiss Franc.

ETF Flows
Total AUM of all the European ETFs amounts to Euro 165bn. 67.7% of the AUM is focused on the equities followed by 14.0% on the debt and 11.8% on the commodities. European ETFs, overall enjoyed inflows of Euro 2.4bn (1.4% of AUM) over the last month. While the equity ETFs added Euro 2.1bn (1.9% of AUM) to their assets, Credit ETFs lost Euro 0.1bn (17.7% of the AUM). On the three month basis, equity ETFs added Euro 3.5bn (3.2% of AUM) and Credit ETFs lost Euro 0.2bn (30% of the AUM). At the region level, over the last month, ETFs focused on the European Union overall enjoyed inflows of 6.3% of their AUM while the ETFs focused on Sweden and Germany suffered out flows of 6.8% and 3.2% of their AUM.


 Current open positions in the ETF portfolio

We keep the open positions unchanged relative to 1 month ago. We continue to own a high equity weight of 40% in our portfolio (20% USA and 20% Emerging markets). Equities remains also the preferred asset class of the asset allocation team of Deutsche Bank “in the current environment; at current valuation levels and at current levels of implied volatility” .

“db xtrackers MSCI USA TRN” ETF 20% weight
We had bought the ETF “db x-trackers MSCI USA TRN” for three reasons: 1) Our economists expect an ongoing strong recovery of the US economy. They expect an US GDP growth 2010E of 3.6% compared to 1.5% for the Eurozone. Our US economists expect the US economic recovery to be led by outright inventory investment, a sharp improvement in capital spending and a healthy bounce in consumer demand for durable goods. Commercial real estate and net exports are likely to be drags on activity, along with spending at the state and local level—although some of this could be offset by larger federal spending, the result of further disbursement of stimulus funds. 2) Our US equity strategist expects a continuing performance of US equities. Our US-Strategist has an S&P 500 target of 1325 for end-2010, an upside of 17% from current level of 1133 (for details see “US 2010 equity outlook: The shape of things to come”, 16 December 2009, 40 pages). 3) A recovery of the US-Dollar would be supportive for the performance. Our FX strategist expects a recovery of the USDollar to a level of 1.40 USD/Euro on a 12-month view Also the US housing sector seems to have bottomed. Main risks for buying the ETF “MSCI USA TRN” are a weakening of the USDollar, negative news flow from the US economy, major earnings downgrades for US companies and declining US equity markets.

“db xtrackers MSCI Emerging Markets TRN” ETF 20% weight

We continue to own the ETF “db x-trackers MSCI Emerging markets TRN” with 20% weight. Regionally, Asia ex-Japan constitutes more than 50% of the total weight of the index. At the country level, China, Brazil, Korea, Taiwan; India, South Africa and Russia have the largest weight in the index. Reasons in favour of many of the major emerging markets include attractive demographics, superior GDP growth, improving skill levels,  huge FX reserves and active SWF funds, large stimulus packages, higher fund inflows and a banking system that is largely unaffected by the financial turmoil. The points above are discussed in more detail in the report Globalisation after the credit crisis, 9 September 2009. The report discusses the relation between demographics and asset prices. The more favourable demographics in many emerging markets compared to developed countries suggests also a more favourable development of asset prices in the longer term. The report also discusses the structural power shift from the developed/Western world towards the emerging world and emerging market companies in detail. Therefore emerging market companies could well benefit from continuing globalisation over the next years more than they did in the past 10 years. The global integration has led to industrialisation in the emerging markets and de-industrialisation in the developed countries. From this trend the large global players in the developed countries have benefited in the last decade. But the emerging market companies may well seek to compete more aggressively with the developed countries in the next decade and benefit from rising skills sets in emerging markets as well as the strong growth rates in their home countries. Main risks for buying the “MSCI Emerging Markets TRN” ETF are a general decline of equity markets and an increased risk aversion of investors. Also major political tensions in major emerging markets like China, Brazil or Taiwan would be a negative. “Emerging Markets Liquid Eurobond Euro Index” ETF 10% weight We had bought the ETF “Emerging Markets Liquid Eurobond Euro Index” mainly because of the attractive coupon of 7.6%. 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 ETF “Emerging Markets Liquid Eurobond Euro Index” has a quite different regional exposure than the “MSCI Emerging Markets TRN”. The two major regional blocks in the “Emerging Markets Liquid Eurobond Euro Index” are Latin America with 43.5% weight and Emerging Europe with 42.6%. 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 with 13.2%, Mexico with 10.5%, Turkey with 10.1%, Brazil with 9.5%, Philippines with 8.0% and Russia with 7.4%. 46% of the portfolio is rated BBB and 36% is rated BB. Any rating below BBB is classified as speculative or junk bond and this currently is the case for 49% of the index volume: 36% of the index is 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.

“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.

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.

 

TI 11-01-2010

 

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
benchmark.