We stay the course with our current ETF portfolio and have made only a small change…..
Staying the course
We buy the db-xtrackers “Stoxx600 Healthcare” with a 10% weight and sell the commodity index DBLCI-OY Balanced ETF with a 10% weight. Our current positions are “DJ Stoxx600 Banks short” ETF with a 30% weight, “IBOXX Euro Sovereigns Eurozone 1-3 year” ETF with a 25% weight, “IBOXX Euro Sovereigns Eurozone 1-3 year” ETF with a 15% weight and the “Currency valuation” ETF with a 20% weight .
Equity markets fell in recent weeks as investors have become more cautious over the last four weeks and wait for a fundamental confirmation of the strong rise in equities, which the data from the real economy have not provided so far. Furthermore, it seems that the outlook for H2 will be less encouraging than expected for many companies. Consequently, the global environment for the equity markets looks set to remain unfavourable in the weeks ahead. The same seems to apply to the commodities markets. After a strong rally, commodity prices have dipped recently, and we do not expect a considerable rebound in the near future. The fixed-income markets, in contrast, have been supported by the very benign inflation data at a global level. In general, we do not expect significant changes in recent trends within the various asset classes. Therefore we keep our cautious and defensive stance in our portfolio. The main risk to our current positioning is a strong rise on the equity markets.
The global equity markets have performed strongly in the last few months, mainly driven by a strong rise in business expectations. In addition, investors priced out the expected collapse of the banking system, a scenario which, we believe, was priced in Q1 2009. But now investors wait for a fundamental confirmation of the recent strong rise in equities, which the data from the real economy have not provided so far. Moreover, investors have become worried about the upcoming earnings season and possible disappointments. Furthermore, it seems that, on average, the outlook for H2 will be less encouraging than expected for many companies. Consequently, the global equity markets fell in recent weeks and we expect the environment for the equity markets to remain unfavourable in the weeks ahead. The same seems to apply to the commodities markets. After a strong rally, commodity prices have recently declined strongly and we do not expect a considerable rebound in the near future.
The fixed-income markets, in contrast, have been supported by the very benign inflation data at a global level. In our view, market expectations have shifted from an inflationary to a deflationary environment or very low inflation in the next few months. Furthermore, the ECB has provided much liquidity to the euro-area money markets, which is why money-market rates have declined significantly. As the yield curve in the euro area has already reached historical highs, the drop in money-market rates was very supportive for the euro-area bond markets, too. Besides the real economic development, a rise in risk aversion seems to be the main reason for the recent developments in the financial markets. Our flow-of-funds data suggest that there were outflows from riskier asset classes, while the money and bond markets have benefited from inflows in recent weeks.
Generally speaking, we do not expect significant changes in recent trends within the various asset classes. The equity markets are expected to drop next week, while fixed income should be supported by low inflation, firm money markets and rising risk aversion. Concerning the commodity markets, we do not expect a recovery in the near future. We therefore keep our autious and defensive stance in our portfolio. We even reduce the beta of the portfolio, as we sell our long commodity exposure and buy the DJ600 healthcare sector. In addition, we keep our short position in the European banking sector, as we still expect negative news from this sector in the next few months. In particular, the possible increase in the number of insolvencies looks set to be a burden for the sector. We stick to our fixed-income exposure.
The ECB should keep the refi rate at the current level and thus support the short end of the yield curve. Longer durations should benefit from further favourable news from the inflation front. Additionally, the rise in risk aversion and the relatively steep yield curve will keep a lid on rates in the next few weeks. Overall, we changed our portfolio only marginally. The main risk to our current positioning is a strong rise in the equity markets.
IDEA of the month:
Buy ETF “db x-trackers Stoxx600 Healthcare”
Healthcare is by far the most defensive sector within equities. The sector is less dependant upon the general economic development than the other equity sectors. The sector’s defensive character has been apparent over the past 3 months as we’ve seen small Healthcare earnings upgrades in contrast to strong downgrades in most other sectors. We expect Healthcare to stand out with stable earnings versus continuing downgrades in most other sectors. Healthcare now looks attractively valued as the sector has a lower P/E than the Stoxx600 for the first time in a decade (see right chart next page). The sector looks also attractive on CROCI valuation. Long term trends which support the sector are an ageing population and rising demand from emerging markets. The proportion of people aged over 65 in Europe is expected to increase from 17% in 2008 to 25% in 2035. Healthcare is a cash-rich sector where many companies have low debt levels. Risks for the sector include high exposure to the US market and to US healthcare reforms. America represents 43% of the sales of European Pharma companies. Consequently, Obama’s planned Healthcare reform is very important for European Pharma companies as the reforms flag significant savings. Another risk is the unprecedented level of potential patent expirations in 2011 and 2012 which could curb sales growth.
“db x-trackers DJ Stoxx 600 Banks short” ETF 30% weight
The Banking sector has been in focus for the past 18 months. The sector saw a strong ongoing price decline until Mar 2009 and a strong recovery until 11 June. Since then the Banking sector has fallen by 9% and in our view this trend could well continue. The Banking sector has the second highest Beta of all Stoxx sectors with 1.6 and our Underweight position expresses our cautious stance on the overall market. Fundamentally the situation for banks has not really improved over the last four months. Write-downs of “toxic assets” which affected banks in 2008 could well continue in 2009 as many banks still possess high amounts of these assets. The European Central Bank expects euro-zone banks to write down another $283 billion by the end of 2010 and sees the bloc’s total crisis-related losses at $649 billion, at least clearly below the $904 billion the International Monetary Fund forecast in April.
The ECB has warned that risks to euro-zone financial stability “remain high”. Among the central bank’s worries are: Sharper-than-anticipated falls in U.S. house prices, further pressure on the euro-zone banks’ capital buffers and the possibility that economic upheavals across Central and Eastern Europe — where some euro-zone banks have big investments — could intensify. Other sources of concern include rising corporate-default rates, fallino property prices in some euro-zone countries and the potential for the bloc’s recession to be worse than expected. The need for banks to reduce leverage will also reduce new business opportunities in 2009. 12-month forward earnings of European banks has fallen by 27% over the past three months and by 15% over the past month, so the downgrade momentum for European banks remains strong. In addition, earnings uncertainty for Banks remains very high. High earnings uncertainty is reflected by huge amounts of “toxic assets” in the bilance sheets. Risks to the call include a strong recovery in equity markets in general, a faster normalisation of the banking business than expected and takeovers in the banking sector which could drive the sector valuation further upwards.
“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. The “Currency valuation index” has generated an annualised Total return in USD of 7.82% since June 1989. 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, Japanese Yen 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 or the Japanese YEN
Trading portfolio
We also hold the “db x-trackers iBoxx Euro Sovereigns Eurozone 15+ TR Index” with 15% weight and the “IBOXX Euro Sovereigns Eurozone 1-3 years” at 25% weight. The current yield of the EONIA benchmark index is very low and in our view could well remain low for some time. Therefore we find it not attractive to shift money back into the EONIA benchmark index. The risks to these two positions are relatively low, in our view. But the main risk is a rise in interest rate level short term and long term. The trading portfolio below reflects the changes discussed above. The portfolio targets absolute return and has the EONIA index as benchmark.
Source: Trading Ideas ETF: Ideas and Flows – Deutsche Bank AG
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