The biggest winner coming out of the financial crisis was “transparency”.
The US Federal Open Market Committee will convene this week to discuss raising interest rates. ETF Securities doesn’t believe they will pull the trigger on this occasion, given the uncertainty surrounding the deceleration of China and Europe and elevated financial market volatility
Hedge bearish sentiment with short ETPs, focus on quality equities offering superior Income
· Macro: The steep correction in global markets today as a result of fears that China’s managed slowdown is turning into a global meltdown may be overdone. This on the back of a resilient US labour market and firming economic growth in the Eurozone. Note also that the potential for China to unleash more stimulus at the monetary and fiscal front is significant, given the minimum deposit requirement ratio of 18.5% to be much higher than the 15.5% level in 2009 and a 12M policy rate of 4.85% that against decelerating inflation is too high a borrowing cost in real terms.
· Valuations: Financial markets may continue to succumb to further weakness and heightened volatility in the near term. Many equity markets, most notably in the US and Europe, trade at forward P/E valuations in the mid teens (S&P 500= 16.7x, DAX 30 = 12.3x, EURO STOXX 50 = 13.6x, FTSE 100 = 14.8x). While not expensive at current levels, there is ample of room for equity prices to fall further and hit extreme low valuations before sentiment in equities improve and falling price momentum reverses.
· Your tactical China hedge: Geared short ETPs: Hedging against China’s worsening outlook: the slumping commodity prices magnify deflation fears and push China’s overleveraged producers closer to the brink of corporate defaults. The extent of the correction of base metals prices has been disproportionate to the devaluation of the RMB and as a result has done little to revive China’s corporate outlook.
· Efficient hedging in volatility assets classes: the global downside momentum across risk assets presents an opportunity to prolong geared short positioning in notably, European and US equities, copper and crude oil to maximise potential returns or deploy minimum capital to hedge your long equity and commodity exposure
· Your strategic quality income focus: allocate into dividend paying equities offering high dividend yield within Europe and US. Coupled with a delayed turn in the interest rate cycle, the added dividend yield premium over bonds instigated by the sharp correction presents an opportunity to take advantage of deep value in Europe and US, as share prices of quality stocks being brought down by sentiment and not by sound longer-term fundamentals. Eurozone equities’ dividend yield of ~4% compare favourably to the yield on German 10Y Bund of 60 bps or Italian BTPs of 1.7%.
· Avoid Value Traps inherent in baskets overly exposed to small-and midcap stocks with highly concentrated business models and yield weighted strategies. Seek Value within diversified large-cap basket tilted strategies where the deep value opportunity is apportioned by cash dividends, not yield.
· Tactically hedging against souring sentiment in risk assets (both within equities and commodities) can be done in several ways:
Commodities: Short industrial and energy commodities, long precious metals
Hedge against downside risk to commodity prices through buying geared short copper and crude oil, go geared long gold and silver . 3x short ETPs tracking crude oil are up over 90% over the last month. Note the efficiency of shorting copper and crude oil, as the 3x geared short ETPs tracking these commodities outperformed their respective delta one underlying by more than their leverage factor.
Source: WisdomTree Europe
Second through shorting equities, the most sensitive to China being Eurozone and specifically German equities.
Buy 3x short ETPs tracking DAX 30, FTSE 100 and EURO STOXX 50 to hedge long European equity positions. German stock’s global export exposure (most notably to China and US) has worked to make the 3x short ETP tracking the DAX 30 the best beta play on souring sentiment on risk assets. Together with short ETPs tracking the UK large-caps / mid-caps and US large caps, the efficiency of hedging equity market risk is evident from better than expected performance relative to delta-one underlying benchmarks
Source: WisdomTree Europe
Third through bullish euro bearish dollar trade as Fed delays tightening
Position short dollar, long euro, given how much of market expectations have been built up around the Fed hiking interest rates this year for the first time in a decade. A rate hike as soon as September is unlikely, and may come at the end of Q4.
The 5x short USD long EUR ETP that tracks to USD/EUR FX spot rate has risen 16% in the last month
Source: WisdomTree Europe
Gold posted a third consecutive week of gains and gold ETPs finally broke a 10-week streak of outflows. Uncertainty around China’s currency policy, volatile equity markets and the realization that a September Fed hike is not a done deal drove the price higher
Gold ETPs see highest inflows since January. Physical gold ETPs received US$230.6mn of inflows last week, as rising prices has lifted the negative sentiment against the metal. Futures market shorts have also been trimmed for the fourth consecutive week. While a confluence of factors has driven gold prices higher, a standout observation was that the VIX index rose 87% last week, signaling a market shift from greed to fear. Gold has traditionally been the first port of call in times of market stress.
Eight consecutive weeks of oil ETPs inflows follow sharp price declines. Bargain hunting continued last week with US$71.8mn of inflows into long oil ETPs. Brent fell 5.3% and WTI declined 2.6%, as the global production surplus accelerates. WTI had fallen to a 6 ½ year low. ETP investors realize that such low prices will drive a reduction in capex and eventual fall in production, but for now crude inventories in the US are still rising, depressing the price. US oil rigs also continue to reopen, adding to supply. ETP investors will need to be patient and bear with the lag in the response from producers.
ETFS Daily Leveraged Natural Gas (LNGA) received highest inflows in 11 weeks. Natural gas inventories rose less than expected (53Bcf vs. 59% Bcf expected), driving a temporary rally last Wednesday and Thursday. The current period of seasonally high demand from the power sector’s air conditioning needs will likely come to an end in autumn and could place downward pressure on price. LNGA received US$4.3mn last week.
Investors trimmed long coffee ETP exposure by US$4.3mn. With the Brazilian harvest coming close to an end, the realisation that last year’s drought has led to smaller bean sizes this year has driven up prices in recent weeks. However, a benign winter has minimised frost-damage and so what the harvest lacks in quality will be made up for in quantity, which has driven prices lower over the past week. Coffee suffers from a weak Brazilian Real, which has encouraged Brazilian farmers to offload stocks cheaply. Sugar conversely rose 1.2% last week, as concerns around poor monsoon rains in India could lead the market into balance for the first time in six years. Long sugar ETPs attracted US$1mn of inflows.
ETFS Palladium Trust (PALL) saw US$12.0mn of redemptions, the highest since September 2014. With Chinese auto demand remaining soft, prospects for global autocatalyst demand, which accounts for 70% of palladium use, remains poor. However, tightening emissions regulation in Europe in September could see the loadings of platinum group metals rise.
Key events to watch this week. Central bankers will convene at Jackson Hole, Wyoming at a pivotal juncture in the Fed’s rate cycle. Consensus expectations are for a September hike, but speeches and presentations by policy makers could sway opinions.
Nitesh Shah - Research - ETF Securities