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The Great Recalibration: The Appearance Of Risk Aversion In Credit Spreads And Equity ETFs

I have noticed a trend toward risk aversion that may adversely affect U.S. stocks. Investors may be in the process of adjusting their expectations for what central banks in Europe, Asia and the United States are capable of achieving. Sure, central banks may try to prevent recessions; they may attempt to inflate stock prices, decrease borrowing costs and/or depreciate currencies. In the end, though, their powers may extend no further than the collective confidence of market participants. Investors have seen a great deal of volatility in U.S. treasuries over the past six months. Early in the year, the combination of recessionary data stateside as well as quantitative easing (QE) measures in Europe helped propel demand for U.S. sovereign debt. Then came the massive unwind, alongside Fed hints at upcoming rate hikes; treasury yields spiked. More recently, the Greece default and the market meltdown in China gave treasuries their groove back. At present, the 10-year yield (2.25%) sits pretty darn close to where it sat at the start of 2015. If I had to project where that yield would be at the end of the year, I’d tell you that it might move up, down and around, but that it would ultimately be near where it is today. I feel the same way about the greenback. In essence, I anticipate that the U.S. dollar may jump around, but that it will not move substantially higher or lower over the next 6 months. In other words, irrespective of financial system shocks, geopolitical uncertainty or central banker gamesmanship, both the buck and the 10-year may be directionless. If I see little reason to invest in the greenback or bet against it, if I do not see value in adding meaningfully to treasuries in a portfolio or betting against them, why discuss U.S. sovereign debt or the U.S. currency at all? Primarily, I have noticed a trend toward risk aversion that may adversely affect U.S. stocks. Take a look at the price ratio between treasuries and crossover corporates – U.S. company bonds that span the lowest end of investment grade (Baa) universe through the highest-rated “junk” (Ba) arena. One can do this by comparing the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) with the iShares Baa-Ba Rated Corporate Bond ETF (BATS: QLTB ). In essence, since March, there have been higher lows in the price ratio and a consistent ability for IEF:QLTB to maintain above its long-term trendline. Moreover, the momentum in IEF:QLTB indicates a widening in credit spreads such that investors may be increasingly turning toward the return of capital over a return on capital. The credit spread evidence is hardly an indication of blood in the streets of Pamplona. Nevertheless, the iShares MSCI Spain Capped ETF (NYSEARCA: EWP ) sits near 2015 lows; its current price is well below a long-term 200-day moving average. Indeed, investors may be doubting the ability of the European Central Bank (ECB) to find a path forward. It is one thing to express a desire to “do whatever it takes” to preserve the euro-zone. It is another thing to keep debt-fueled excesses from fracturing alliances. Granted, the People’s Bank of China (PBOC) may eventually contain the fallout from the lightning quick collapse of Chinese equities in Shanghai. And central bankers may yet find a way to kick the toxic debt can down a European cobblestone path; that is, a disorderly “Grexit” for Greece is not an absolute certainty. Even the upswing in S&P 500 VIX Volatility (VIX) is merely a sign that folks are willing to pay a little bit more for index option protection than they were a few weeks earlier. On the other hand, the deterioration in U.S. stock market internals has been decidedly bearish. Both the NYSE Composite and the S&P 500 have significantly more 52-week lows than 52-week highs. Similarly, the number of advancing stocks relative to the number of declining stocks for both indexes has been steadily dropping since mid-May. What these breadth indicators tell you is that fewer and fewer stocks are carrying the entire ship. Like Atlas trying to hold the weight of the world on his shoulders, should he shrug, the benchmarks may buckle. If nothing else, we may be witnessing a “Great Recalibration.” (Did I just come up with a new term?) Investors may be in the process of adjusting their expectations for what central banks in Europe, Asia and the United States are capable of achieving. Sure, central banks may try to prevent recessions; they may attempt to inflate stock prices, decrease borrowing costs and/or depreciate currencies. In the end, though, their powers may extend no further than the collective confidence of market participants. Here’s a look at one last chart that supports the notion that the smarter money may be moving toward risk-off assets. On a month-over-month basis, the FTSE Multi-Asset Stock Hedge (MASH) Index is outperforming the S&P 500. The MASH Index is a collection of non-stock assets that tend to do well in bearish environments, including the yen, the franc, munis, long duration treasuries, inflation-protected securities, German bunds and gold. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

Spain Is The Next Greece – Avoid EWP

Summary A political push is underway in Spain that appears to me to have a lot in common with Syriza’s rise to power in Greece. Leftist politicians have won a majority of Spain’s municipal elections and taken control of key cities including Madrid and Barcelona, and they have their eyes on national control. If Spain is going to be the next Greece, then its future actions and direction are not likely to sit well with its Eurogroup partners. The investment community is likely to see this as “contagion,” and that does not bode well for the euro, European equities, and judging by the developments in Greece, Spanish equities. Thus, no matter what happens between Greece and its creditors, it would seem wise to avoid Spanish stocks and the iShares MSCI Spain Capped ETF. Some pundits believe that any sort of closure for the Greece issue is a plus for Europe, whether Greece stays in the eurozone or leaves it. But there is one European market sector that I do not see a positive outlook for either way. Spain looks to be the next Greece because of a political circumstance similar to what occurred in Greece before the current crisis heated up. Thus, I suggest investors sell the iShares MSCI Spain Capped ETF (NYSE: EWP ) and Spanish stocks generally. A succession of leftist political victories in Spain too closely resembles what happened in Greece before it raised issue with its creditors. I believe it will lead to division between Spain (perhaps emboldened now by Greece’s display of strength) and more progressive economies to the North. While Spain is not in the same situation as Greece, its political policies and direction moving forward are likely to trouble investors. Before Syriza, a decidedly left wing party, was elected into power in Greece, everything seemed to be improving, at least from our perspective over here. The economy was growing and the budget was operating at a surplus. Yes, there was still extremely high unemployment and unbearable taxation for a people suffering in strife, but from the perspective of those on the outside Greece was doing better. It was, in the end, the pain and suffering of the people that allowed the political candidate (Tsipras) calling for an end to austerity to overcome the reigning government’s plea for patience. Guess what’s happening in Spain today? The Leftists are Coming! This month, a wave of leftists (not my description) won victories in municipal elections across Spain. The political push in Spain sure resembles the same movement that took control of Greece and led Europe and relative investors into today’s turmoil. In the comment section of the article I linked to here, the first comment says something like, “This must be the Greek contagion they were all afraid of. This won’t end well.” I agree, but would add, this won’t end well for European stocks and debt and the euro, and especially Spanish equities. The newly elected municipal leaders in Spain easily overcame their predecessors with popular campaign pleas. For instance, one new mayor is working to put the victims of foreclosure (that’s how they see it) into homes foreclosed upon and held by banks. Back in Greece, Syriza won with promises to hire back laid-off public sector workers, reduce taxes and to restore old pension norms. But what the so-called leftists in Greece and Spain will have in common is an aversion to German inspired austere budgeting. So then the leftists in Spain are likely to cause a fuss, and I suspect they’ll stare their national intentions now that the Greeks are on the marquee. Opportunistic politicians with plans to take control of Spain this year should find opportunity now to organize gatherings in support of the Greek people. I would be surprised if it doesn’t happen. It will draw global investor attention to the contagion they all feared might spread across the PIIGS (Portugal, Italy, Greece, Spain – I’ll leave out Ireland) of the eurozone periphery. And when the leftists unseat the ruling power atop the Prime Ministry in Spain this year as I expect, we will all have to take note. 10-Year Chart of EWP at Seeking Alpha Just like it played out for Greece, none of this weighs well for Spanish stocks. It portends rather that this 10-year chart of the iShares MSCI Spain Capped ETF , which seems to show stocks going up and down before ending up at the same place, will continue to do so while sporting a new leg lower. Indeed, EWP was one of the poorest performers of the eurozone on Monday, as this secret seems to be leaking. EWP fell 5.2% on Monday, while the iShares Europe ETF (NYSE: IEV ) dropped just 3.4% and the iShares MSCI Germany ETF (NYSE: EWG ) fell 4.0%. The Global X FTSE Greece 20 ETF (NYSE: GREK ) fell 19.4%, since it was the star of the show. Take note that the German ETF was doing quite well this year, but EWP had a negative year-to-date performance record heading into the black day for Europe. Things just got worse for Spain. The political change overtaking Europe is a problem for the euro, but the Swiss National Bank (SNB) and the European Central Bank (ECB) have managed to manipulate the currency well enough to turn a 1.9% overnight loss into a sharp gain by Monday afternoon. The SNB flooded the market with Swiss francs (the safe haven for capital running from the euro at the time) to weaken the franc unnaturally against the euro and support stability (or illusion) in Europe. It’s going to get harder to hide this mess, though, when the Spaniards hit the streets in solidarity with Greece or when these new party candidates win national elections. I found a CNBC report interesting today, as I watched Sarah Eisen report that currency traders believe the euro has not yet given way because of no sign of Greek contagion. Well, I agree but I’m saying that is exactly what is about to change. So, friends, I would keep this in mind when venturing investments in European shares and especially when considering the iShares MSCI Spain Capped ETF, which I would avoid. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

European QE: Implications And Investment Opportunities

Summary The European QE, while beneficial, will have different impact and consequences than the US and the UK style QE. The retail European market is not as well developed as in the US, UK so the main risk asset likely to benefit from a large QE will be real estate. Countries with largest equity markets to GDP like the Netherlands, Belgium, France and Spain will benefit disproportionately from a risk on equity trade. Difference between European QE and US and UK style QE The European QE announced by ECB last week consists of a monthly Euros 60 bn private and public bond buying that will last until at least September 2016. The euro denominated debt purchases will be all along the yield curve between 2 and 30 years maturities and will represent no more than 25% of each issue. The debt purchases will be mutualised, sharing the loss up to 20% and the rest of 80% will stay with the national central banks. Interestingly, the government debt to be acquired by ECB is investment grade only so Greece and Cyprus debt will likely not be considered for this QE round. While both the Fed and the BoE bought back government debt, so in nature the style of the ECB QE is similar, the lack of debt mutualisation across the Euro zone will skew the benefits towards the countries with best fundamentals in 2016 when the QE starts to slow down. In addition, the funding transmission mechanism in the Euro zone does not work quite the same as in the US or in the UK. Lower rates across the euro zone should lower rates for corporates and individuals but we may not see the impact of these rates in the short term and uniformly across the Euro countries. Euro corporates use far less bond debt than the UK Plc or the US corporates. Even though the European bond market has seen significant growth after the 2009 financial crisis, the majority of the corporate debt, especially for the long term maturities and for the small and medium sized companies, is still bank debt which will be slow to adjust to market yields. The positive and perhaps intended long term consequence here is that it may encourage SMEs to increase financing with corporate bonds issuances in the eurobond market, just like it did after 2009 when bank liquidity dried up. So in the medium and longer term – this is some of the SMEs in Spain and Italy and other non-core Euro markets where the bank lending rates are at 4-6% (Reuters). Most of the immediate positive impact however will be on the larger Eurozone corporates from Germany, France, Spain and the Netherlands (that operate mainly within the Eurozone and as such don’t have a negative currency impact on their revenues) and who can improve their average debt rate substantially. Eurozone mortgages are by and large fixed mortgages from 1 to 5 years and longer and refinancing for these mortgages is not straightforward. While the proportion of variable rate mortgages has increased since 2009, the fixed rate mortgages are still predominant in France, Italy, the Netherlands and Germany, so it will take some time for the wealth effect from lower mortgages and refinancing to have an impact on the consumers in these markets. On the other hand, countries like Spain and Ireland, where most mortgages are based on variable rates may benefit most on short term. Investment Implications As yields are going down, institutional and individual investors are likely to chase higher yield assets like equities, high yield bonds and alternative assets like real estate and private equity: Equity markets in the Eurozone are not as developed as in the UK or the US relative to the size of their GDP. As the chart below shows, the ratio of the equity market to GDP in some European countries like Germany at 54% or Italy at 15% is incredibly low when compared to the UK or the US. Countries with the most developed equity markets, like the Netherlands (NYSEARCA: EWN ), Belgium (NYSEARCA: EWK ), France (NYSEARCA: EWQ ) and Spain (NYSEARCA: EWP ) will likely benefit most from a risk on equity trade. (click to enlarge) Source: Gurufocus, ECB, Reuters Low rates will benefit new investment in real estate and we are likely to see real estate prices going even further up especially in countries where equity markets are not very popular and in countries with mostly variable mortgage rates. Despite a strong performance in the past year, German REITs like Deutsche Wohnen ( OTC:DWHHF ) and Deutsche Annington ( OTC:DAIMF ) are still the best positioned to take advantage of a rising real estate market. Some Spanish real estate developers like Immobiliaria Colonial [COL.SM] may also be an interesting though volatile play. (click to enlarge) Source: Bloomberg Lower Euro will likely bring significant positive changes, even though some economists don’t think so as too many of the goods produced by the euro companies are outside of the Eurozone territory. The services sector, especially the travel and leisure sector including companies like TUI AG, is a clear winner from a lower currency. The SMEs and the corporates with competitive manufacturing bases in the Eurozone exporting outside of the area will also benefit. A lower exchange rate for the Euro will further support the exporters, especially the largest two exporters in the Eurozone who are also highly competitive manufacturers: mostly Germany (which according to WTEx, produced about 29% of the European exports in 2013 and has a large SME sector) and to a lesser extent the Netherlands (with about 9-10% of the European exports in 2013 but a smaller SME sector). In Italy only, the estimated boost to GDP from a lower currency is about 0.6% per year ( CSC, Il Sole 24) While the QE benefits will be widely spread and may give a fresh respite to countries like Italy and France, somewhat ironically the largest positive impact will benefit the countries that have fought it mostly. The Dutch and to a lesser extent the Belgian equity markets and real estate sectors in countries like Germany and Spain will likely be the big winners. Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in EWN over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Editor’s Note: This article discusses one or more securities that do not trade on a major exchange. Please be aware of the risks associated with these stocks. Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in EWN over the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.