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A Eurozone Play

Richard Croft
March 2, 2015
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5 minutes read
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On January 15th, the Swiss National Bank (SNB – Switzerland’s central bank) removed its’ self-imposed restrictions on the Swiss Franc. A major shift in policy shrouded in secrecy at a time when central banks had been trying to be more transparent, which many felt would have dire consequences for the Swiss economy. Note the quote from Nick Hayden Chief Executive of Swatch a major Swiss exporter who opined at the time; “Today’s SNB action is a tsunami; for the export industry, for tourism, and finally for the entire country.”

The fallout from the SNB announcement was immediate. The Swiss Franc rallied 30% against the euro and companies like Swatch fell 16% as the cost of their goods destined for European buyers surged 30% in an instant. The Swiss stock market declined a precipitous 7% in one trading day.

Makes one wonder why a powerful central bank known for its conservative mind-set would appear to act so recklessly. It turns out that the SNB was caught between the proverbial rock and a hard place. It simply had no choice.

It was 2012 when the SNB initially pegged the value of the Swiss Franc at 1.20 to 1.00 euro. The self-imposed ceiling was intended to halt the Swiss Franc’s appreciation which was, among other things, causing problems for Swiss exporters. In hindsight, the January 15th SNB decision was a precursor to a €1.6 trillion bond buying program (i.e. quantitative easing or QE) announced by the European Central Bank (ECB).

As expected the euro immediately fell against the so-called safe have currencies such as the US dollar and of course the Swiss Franc. Clearly the SNB felt that it did not have the resources to defend its 1.20 to 1.00 euro peg against currency traders engaged in a flight to quality. Interestingly, all of this has taken place before the ECB has even begun printing the necessary euros to fund its’ bond buying endeavours.

Beyond the currency impact, I think the ECB has created an interesting opportunity. After two years of skirting the issue, the ECB has embarked on a program that will ultimately do what Mario Draghi has always said he would do; defend the Eurozone at any cost!

That is not to suggest that we will see a bump in Eurozone economic activity because, like the US experience, I suspect the ECB bond buying program will end up strengthening the balance sheets of European banks and probably light a fire under the various Eurozone stock markets by expanding P/E multiples and bolstering stock re-purchase programs.

To that point, traders are reminded of the 2013 rally in US stocks following the October 2012 announcement by the US Federal Reserve of QE-III. Since the ECB’s program is similar in size to QE-III, we may see some decent gains in European stocks during 2015.

The challenge is to take advantage of a surge in European stocks while hedging out the risk of a declining Euro. One product that comes to mind is the iShares MSCI EAFE Index ETF (symbol XIN, Friday’s close $24.48). XIN is not a pure play but it does provide exposure to European stocks and hedges the currency back to the Canadian dollar.

XIN has already rallied 9.97% since the beginning of the year but I think there is more to come. I note for example that money managers are warming to the idea of a stronger Eurozone in 2015. More than a few have opined that European stocks look relatively inexpensive when compared to the S&P 500 Index. And with the bond buying program just beginning, we should see it impact Eurozone stocks as the snow begins to melt.

Aggressive option traders might consider buying some longer term in-the-money calls to take advantage of this scenario. Specifically look at the XIN September 24 calls at $1.25.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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