Is This a Good Time to Short the Eurozone?


It is a mistake to look too far ahead. Only one link in the chain of destiny can be handled at a time.” – Winston Churchill


With the US equity markets hitting new highs on what seems a daily basis as of late, investors may be forgiven if they haven’t been tracking the European economy as closely as they had in the recent past, when the Eurozone seemed to be in perpetual crisis mode.

And, with the region recently emerging, though ever so barely, from its most recent multi-year recession, the morbid fascination with the Eurozone shifted to something closer to mild disinterest.

The fact is that the European bourses have mainly mirrored Wall Street’s success this year, though to a somewhat lesser degree.

For example, while the S&P 500 index has gained over 27% year-to-date as of last Friday, VGK (Vanguard FTSE Europe ETF), which is the largest of the European equity ETFs in terms of capitalization, was up 16.99%.

VGK tracks the FTSE Developed Europe Index, which consists of over 500 common stocks of 17 European countries, and serves as a reasonable proxy for the region’s equity markets.

The thing is, the uptrend in the area’s economy is at least partially based on the perception that the Eurozone has become a more stable market, which can be greatly attributed to the European Central Bank’s (ECB) bold proclamations that it is ready to take whatever action is required to keep the monetary union intact.

One of the tools used by the ECB back in late 2011 was the LTROs, long-term refinancing loans that served to introduce increased liquidity into a banking system that was seriously flailing at the time.

The first wave of LTROs was wildly successful in its mission, and a second wave followed not long after.

The cheap loans to the banks totaled $1.36 trillion dollars and were widely credited as a key to stemming the flow of blood being spilled by the PIIGS (Portugal, Ireland, Italy, Greece and Spain) at that time.

Fast-forward to the present, and a large portion of the cheap money has been repaid to the ECB by the banks. As a result, excess liquidity has reverted to 2011 levels.

So now, in an effort to boost the liquidity levels, and more importantly, help prop up the region’s fragile economy, the ECB is mulling a new version of the LTRO. This time, however, there would likely be certain restrictions on how the money was used, something that wasn’t in place for the original LTROs.

One restriction being proposed by the ECB’s president, Mario Draghi, is that the banks can only use the funds for loans that are most likely to boost the economy, as opposed to boosting just the bank’s bottom line. Such loans would go towards those businesses that are focused in the industrial, retail, and services sectors.

Whether the banks take the new money remains to be seen, as the conditions imposed by the ECB may serve as enough of a deterrent to discourage them from taking up the offer of the new LTRO funds.

In any event, the current trend in the Eurozone is one where credit is not adequately going to the areas most needed to support the region’s stagnant economy.

Unless that is corrected, the region could easily slip back into the recession quagmire, which would make a short play on the Eurozone, based on the current high valuations of the region’s equity market, a bet well placed.

What The Periscope Sees

Here is a list of five Eurozone ETFs that have made impressive double-digit gains for the year-to-date. While none of them have quite matched the 2013 breakout performance of the benchmark S&P 500 Index, the returns of these continental ETFs continue to indicate that, at least as far as the equity market is concerned, the EU is alive and well.

The region’s top performing ETFs year-to-date, as of the end of last week:

EWP– iShares MSCI Spain Index Fund, +24.16%

EWG — iShares MSCI Germany Index Fund, +23.77%

FEZ — SPDR DJ Euro Stoxx 50 ETF, + 18.78%

EWQ — iShares MSCI France Index Fund, +18.40%

EWI — iShares MSCI Italy Index Fund, +13.98%

ETF Periscope

Full disclosure:  The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”

Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Daniel Sckolnik or Sabrient. Neither Daniel Sckolnik nor Sabrient makes any representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results.