With most analysts downplaying the prospects for U.S. stocks in 2015, financial advisors might want to shift their attention to Europe. With the European Central Bank (ECB) embarking on a record program of quantitative easing (QE), that should spawn some serious returns for European equities markets. Buying calls on a basket of European stocks would leverage that bet with limited risk.
Actions taken on Jan. 15 by Switzerland’s central bank, the Swiss National Bank (SNB), that removed its self-imposed restrictions on the Swiss franc provided further evidence regarding the size and scope of the ECB bond-buying initiative. Why else would the SNB engage in an action that Nick Hayek Jr., CEO of Swatch Group Ltd., a major Switzerland-based exporter of watches, described as “a tsunami for the export industry, for tourism and, finally, for the entire country”?
On the surface, the SNB’s actions appear reckless. That view was shared by more than a few commentators when the news hit. Certainly, the aftershocks were immediate: the Swiss franc rallied by 30% against the euro; companies such as Swatch, whose stock fell by 16%, saw the cost of their goods destined for European buyers surge by 30% in an instant; and Switzerland’s stock market declined by a precipitous 7% in one trading day.
No other choice
You have to think the SNB felt it had no other choice, as it had pegged the value of the Swiss franc at 1-1.20 to the euro. This policy created a self-imposed ceiling intended to halt the Swiss franc’s appreciation, which was causing problems for Switzerland-based companies that were exporting to the eurozone.
The problem is that with the ECB now embarking on its version of QE, it will weaken the euro and increase demand for safe-haven currencies such as the Swiss franc and U.S. dollar. That the SNB felt it did not have the wherewithal to defend its self-imposed peg speaks to the size and scope of the ECB’s version of QE – a bond-buying program of up to 60 million euros a month. That comes quite close to the U.S. Federal Reserve Board’s recently ended $85-billion-a-month bond-buying program. (All figures are in U.S. dollars.) Furthermore, in the ECB’s case, this is a major central bank that’s buying sovereign bonds from all member states despite the fact that some of this debt is of questionable quality.
What does this situation mean for investors? More volatility, to be sure, and the possibility of a surge in European stocks because there will be no European alternative to equities. The problem is that any gain your client might get in purchasing European stocks will be offset with declines in the euro.
An ETF hedged to the US$
The way around this is to look for an exchange-traded fund (ETF) that tracks European equities markets but hedges out the currency – not to the Canadian dollar, but to the U.S. dollar (US$). An ETF that meets these criteria is WisdomTree Hedged Europe Equity Fund, sponsored by New York-based WisdomTree Investments Inc., recently priced at $58 a unit.
This particular ETF not only tracks European equities markets and hedges the euro back to the US$, it also has listed options, which allows clients to buy into Europe with limited risk. The downside is that this ETF’s options are not liquid. There’s also little open interest and wider than normal bid/ask spreads. So, if you’re considering a long call strategy for your clients, you should caution them that they may be holding these calls longer than is typical for active call-buying strategies.
Thus, you should look at calls that expire in August, which at present are the longest-dated options available on the WisdomTree ETF. The August 60 calls on the ETF were trading at $2.20 a share when the stock was at $58. As European stocks get pumped up with the launch of QE, there may be opportunities over the next few months to sell part of your clients’ positions. Doing so allows your clients to take some money off the table while holding the remaining calls for longer-term appreciation.
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