Trading Ideas March 2010: Increasing the equity weight by buying the Dax


IDEA of the month: Buying Dax 30 index

This month we buy the Dax index with 20% weight. Reasons in favour of Germany and the Dax index include low sovereign risk, a strong competitiveness position (supported by the low rise in labour costs over the last decade), strong trading surplus,…….

a strong Dax earnings growth 2010E (consensus expects 51%) and a moderately attractive valuation. Therefore we would 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 and a restart of significant earnings downgrades of German companies. The sovereign debt crisis in Greece had a significant impact on global financial markets. However, in the last weeks the news flows have become more positive, as the other Euro area countries provided strong verbal support for Greece. The positive developments culminated in a successful EUR 5bn 10Y Greek bond deal. On the other hand the ECB became more confident on the future economic development in the course of 2010, but the inflation outlook remains favourable.

Thus, central bank rates should stay rather low in the next months. Additionally the real economic data improved, which supports a more constructive view on the economy. These developments improved the financial markets sentiment and the equity markets reacted very positively and the Euro could end the recent depreciation trend against the major currencies. In our view the favourable trend in equity markets should continue, as the real economic data and company news should come in favourably. This month we have switched the portfolio from ETFs to indices in order to give a more general form to reflect our views.

Idea of the month: Buying Dax 30 index

This month we buy the Dax30 index with 20% weight. In Europe the country view has come into the focus again recently together with the sovereign risk discussion (for details see also European equity strategy: The return of the ‘country effect’, 2 March 2010). 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. Therefore we would expect the Dax to outperform in a positive equity market environment. We discuss these points in more detail below.

The recovery of European equity markets has continued from October 2009 to March 2010, but clearly less pronounced than from March 2009 to September 2009. Interestingly, the top performing countries in Europe between April and September 2009 have become the bottom performers since Oct 2009: Greece, Ireland, Austria, Spain and Italy have been the strongest performers during the equity market recovery between 1 Apr 2009 and 30 Sep 2009 (see left chart below). Since October 2009 Sovereign risk discussions have intensified and Greece, Ireland, Portugal Austria, Spain and Italy have been the weakest performer since Oct 2009.

Germany as the major country in core Europe and even more the Dax30 companies could well benefit from ongoing discussions around central vs. peripheral Europe. Currently, Germany has a CDS spread of 30 basis point, the second lowest among the countries shown above. Only Finland has a lower spread. The German CDS spread has only moderately widened by 11 basis points over the last 3 months .

Sovereign risk is related to Sovereign debt levels, but potentially even more with the trust of investors in the ability to repay debt. The ability to repay debt may well be related to the competitiveness strength of the country, in our view. One of the most profound and detailed rankings on countries competitiveness is from the World Economic Forum, published annually and the last time in September 2009 Germany is ranked as 7th best countries out of 133 countries, Netherlands is 10th and France is 16th whereas Spain is ranked 33, Portugal on 48 and Greece is 71 (see left chart below). Also in comparison to other major economies in the world Germany’s competitiveness score looks strong with only the USA being ahead of Germany

The competitiveness scores of European countries have some relation to the recent equità market performance since October 2009. European Countries with higher competitiveness scores have outperformed countries with lower competitiveness scores since Oct 2009 (see chart below). Assuming the trend continues in 2010, this would be an argument in favour of buying the Dax index.

More arguments in favour of buying the Dax index can be found by looking at the details of the competitiveness score. Germany has rank 7 on competitiveness in total out of 133 countries using 12 different pillars with 110 factors in total. Germany is ranked 1st out of 133 for the quality of its infrastructure, with particularly good marks for its transport and telephony infrastructure. Its goods market is assessed as being efficient (rank 18), with a high level of competition among companies (rank 21). Besides Infrastructure Germany has strong scorse  within the basic requirements in categories Institutions, Macroeconomic stability, Health and Primary education.

Germany is ranked 2nd globally behind Japan in the pillar ‘business sophistication’. This pillar includes the local supplier quantity and quality as well as the value chain breadth and the Production process sophistication. Germany also benefits from its significant home market size. One weakness of Germany for a long time is the labour market.

The labour market is very rigid (124th for the labour market flexibility sub pillar) and a lack of flexibility in wage determination and the high cost of firing provide a hindrance to job creation. One pillar where Germany has weakened over the last year is the Financial market. Germany’s rank has fallen from 19 to 36 within a year, due to rising concerns about the soundness of banks and more difficult access to capital for business development.

“MSCI USA TRN” index 20% 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. 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. Admittedly the strong winter in Q1 was a burden for many economic data in the US published recently. 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, (for details see “US 2010 equity outlook: The shape of things to come”, 16 December 2009, 40 pages). A strong Q4 reporting season in the US had the following highlights: The bottom line was beaten by 10%, the fourth big beat in a row; 70% of the firms have beaten the Top line and Cash flow came in strong. 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. Banks have strongly underperformed the equity markets over the last months for 2 main reasons. 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 outperform the European equity market, if the negative points above come gradually out of the focus. In addition, Banks remain of the most attractive sectors on the scorecard. Main risk for the Stoxx600 Banks performance is increasing worries on sovereign risk and banks regulations. Also declining equity market is a major risk for the Banking sector. 

 “MSCI Emerging Markets TRN” index 20% weight

We continue to own the index “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 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” index 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” 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 index “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 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. Venezuela is the country with the biggest weight in the index and also the country with the lowest rating

Trading portfolio

This month we buy the “Dax index” with 20% weight and sell “DB Currency valuation TR Index” 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