ECB BOND BUYING MIGHT HELP EURO STOCKS, BUT NOT THE CURRENCY -- THE WISDOM TREE EUROPE HEDGED EQUITY FUND HEDGES OUT WEAK EURO -- CURRENCY VOLATILITY PUSHES MONEY INTO GOLD -- HOMEBUILDERS DROP BACK TO 200-DAY AVERAGE
ECB IS EXPECTED TO START QE TOMORROW... The ECB is expected to announce a quantitative easing program tomorrow (Thursday) which will involve buying sovereign bonds. [A leak today outlining some of the details of that program helped stabilize stocks here and in Europe]. Expectations for QE over the past few months have weakened the Euro and pushed eurozone bond yields to record lows. Shorter-term euro rates are in negative territory. Announcements of bond buying in the U.S. and Japan had a bullish impact on their respective stock markets. Given that history, there's a strong chance that tomorrow's ECB announcent will boost eurozone stocks. But it will probably also weaken the euro. Which brings us to a point that I've made in several recent messages: If you wish to buy European stocks, make sure to hedge out the weaker euro. The next two charts show how important that is. Chart 1 shows EMU iShares (EZU) stabilizing above their October lows in a potential bottoming formation. Chart 2 shows the WisdomTree Europe Hedged Equity Fund (HEDJ) breaking out to a new high. Both charts track eurozone stocks. The striking difference in their performance is the result of the weak Euro. The EZU is priced in U.S. dollars which gained 15% against the euro since midyear. The HEDJ hedges out the currency effect. The 17% difference in their performance is due almost totally to the 15% drop in the Euro.
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Chart 1
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Chart 2
ANOTHER VIEW OF CURRENCY EFFECT ... Chart 3 shows another way to see the effect of the falling euro on eurozone stocks, and the need to hedge the negative currency effect. The blue line is a ratio of the WisdomTree Europe Hedge Equity Fund (HEDJ) divided by EMU iShares (EZU). The green line is the Euro versus the dollar. When the euro is rising (second half of 2012 and most of 2013), EZU iShares (priced in a weaker dollar) will do better than a hedged fund (like HEDJ). The falling euro since mid-2014, however, dragged down down EZU iShares which did much worse than the HEDJ which hedges out the negative currency effect. Be sure to choose the right fund depending on what the ECB does tomorrow, and how the markets react to it.
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Chart 3
GOLD FINALLY CATCHES A BID... A combination of global factors appear to be pushing some money back into gold. One is certainly the prospect of bondbuying by the ECB which has pushed eurozone bond yields to record lows. That has helped pull bond yields lower all over the world (including the U.S.). Falling bond yields help gold which is a non-yielding asset. Negative yields in Europe also encourage gold buying. Another factor that may have boosted gold over the last week was the surprise move by the Swiss central bank last Thursday to lift the "cap" between the Swiss franc and the euro. [That was done in anticipation of this week's ECB accouncement which is expected to weaken the euro even further]. The 20% jump in the Swiss franc (green line) sent shock waves through forex markets and may have pushed some money into gold as a currency alternative. Rising stock volatility during 2015 also increases the appeal of safe-haven assets like gold.
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Chart 4
HOMEBUILDERS FALL BACK TO 200-DAY AVERAGE... On January 8, I showed the Dow Jones Home Construction iShares (ITB) breaking out to an eight year high. [On January 3, I also wrote a bullish article on the rising 18-year real estate cycle]. Unfortunately, the homebuilding groups has taken a hit since then. The daily bars in Chart 5 show the ITB falling all the way back to its December low and its 200-day moving average. That's an important test if the uptrend that started last October is to continue. Today's report that 2014 housing starts were the highest since 2007 has helped stabilize the group. My longer range view on housing remains positive. The recent price drop, however, has pushed the ITB back into the middle of a two-year trading range.
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Chart 5
S&P 500 REMAINS ABOVE CHART SUPPORT... My message from last Wednesday showed the S&P 500 nearing a test of initial chart support in the 1992/1972 region. Chart 6 shows the SPX trying to rebound off its early January low. The December low also corresponds to its 200-day moving average. Very little has changed in the last week. I have the impression that traders are holding back until tomorrow's ECB announcement. If it follows through as expected, global stocks could rally. If it disappoints, we could see the opposite effect. I hope the ECB is up to the task. It's accomplished a lot in the past by talking about doing something. Now, it has to actually do it.
