Global Sell-off in Risk Assets


Hedge bearish sentiment with short ETPs, focus on quality equities offering superior Income

· Macro: The steep correction in global markets today as a result of fears that China’s managed slowdown is turning into a global meltdown may be overdone. This on the back of a resilient US labour market and firming economic growth in the Eurozone. Note also that the potential for China to unleash more stimulus at the monetary and fiscal front is significant, given the minimum deposit requirement ratio of 18.5% to be much higher than the 15.5% level in 2009 and a 12M policy rate of 4.85% that against decelerating inflation is too high a borrowing cost in real terms.

· Valuations: Financial markets may continue to succumb to further weakness and heightened volatility in the near term. Many equity markets, most notably in the US and Europe, trade at forward P/E valuations in the mid teens (S&P 500= 16.7x, DAX 30 = 12.3x, EURO STOXX 50 = 13.6x, FTSE 100 = 14.8x). While not expensive at current levels, there is ample of room for equity prices to fall further and hit extreme low valuations before sentiment in equities improve and falling price momentum reverses.

· Your tactical China hedge: Geared short ETPs: Hedging against China’s worsening outlook: the slumping commodity prices magnify deflation fears and push China’s overleveraged producers closer to the brink of corporate defaults. The extent of the correction of base metals prices has been disproportionate to the devaluation of the RMB and as a result has done little to revive China’s corporate outlook.

· Efficient hedging in volatility assets classes: the global downside momentum across risk assets presents an opportunity to prolong geared short positioning in notably, European and US equities, copper and crude oil to maximise potential returns or deploy minimum capital to hedge your long equity and commodity exposure

· Your strategic quality income focus: allocate into dividend paying equities offering high dividend yield within Europe and US. Coupled with a delayed turn in the interest rate cycle, the added dividend yield premium over bonds instigated by the sharp correction presents an opportunity to take advantage of deep value in Europe and US, as share prices of quality stocks being brought down by sentiment and not by sound longer-term fundamentals. Eurozone equities’ dividend yield of ~4% compare favourably to the yield on German 10Y Bund of 60 bps or Italian BTPs of 1.7%.

· Avoid Value Traps inherent in baskets overly exposed to small-and midcap stocks with highly concentrated business models and yield weighted strategies. Seek Value within diversified large-cap basket tilted strategies where the deep value opportunity is apportioned by cash dividends, not yield.

· Tactically hedging against souring sentiment in risk assets (both within equities and commodities) can be done in several ways:

Commodities: Short industrial and energy commodities, long precious metals

Hedge against downside risk to commodity prices through buying geared short copper and crude oil, go geared long gold and silver . 3x short ETPs tracking crude oil are up over 90% over the last month. Note the efficiency of shorting copper and crude oil, as the 3x geared short ETPs tracking these commodities outperformed their respective delta one underlying by more than their leverage factor.


Source: WisdomTree Europe

Second through shorting equities, the most sensitive to China being Eurozone and specifically German equities.

Buy 3x short ETPs tracking DAX 30, FTSE 100 and EURO STOXX 50 to hedge long European equity positions. German stock’s global export exposure (most notably to China and US) has worked to make the 3x short ETP tracking the DAX 30 the best beta play on souring sentiment on risk assets. Together with short ETPs tracking the UK large-caps / mid-caps and US large caps, the efficiency of hedging equity market risk is evident from better than expected performance relative to delta-one underlying benchmarks


Source: WisdomTree Europe

Third through bullish euro bearish dollar trade as Fed delays tightening

Position short dollar, long euro, given how much of market expectations have been built up around the Fed hiking interest rates this year for the first time in a decade. A rate hike as soon as September is unlikely, and may come at the end of Q4.

The 5x short USD long EUR ETP that tracks to USD/EUR FX spot rate has risen 16% in the last month


Source: WisdomTree Europe