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Trading Ideas July 2010: Reducing the equity weight

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IDEA of the month:  Reducing the equity weight

Today we reduce the equity weight in our index portfolio from 50% to 20%. We sell the MSCI USA from 20% weight to 0% on the back of softening labour markets and a slowdown in GDP growth from its   …….

initial surge. We also reduce the weight of the MSCI Japan from 20% to 10% (see portfolio below). We put those 30% weight back into the EONIA benchmark. The high equity weight of the portfolio was a negative in the weaker equity markets of the last days. The outperformance of our portfolio YTD is now 3.4% (see next page). Given the current volatility and uncertainty we reduce our risk exposure. A 20% equity weight for our portfolio with an EONIA benchmark reflects a mild positive stance on equities which we continue to play via Germany, given that export continues to be strong and recent order intake remain healthy.

We sell the MSCI USA because economic data in the US came in weaker in the last weeks. The US non-farm payroll numbers came in on the soft side as headline payrolls declined -125k. The June ISM dipped to 56.2 from 59.7, the US Consumer confidence fell hard to 52.9 in June compared to 62.7 previously, the US Pending home sales declined 30% in May. The V-shaped recovery seems to have become more fragile in the view of the market. Also China’s manufacturing PMI in June surprised on the downside recently with a level of 52.1, sharply lower than the May reading of 53.9. On the recent G20 meeting in Toronto there was no agreement on new stimulus measures. With this move we follow the scorecard which had became already more cautious on equities earlier . Japan reported recently the first decline in industrial production since February. Our Japanese strategist has also become more cautious recently . We keep our preference for Germany vs. Europe as we own the Dax with 20% weight vs. the Eurostoxx50 short with 10% weight. Germany and German exports still look well positioned as the German real machinery orders came in strong in the last days.

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Source: Trading Ideas ETF: Ideas and Flows – Deutsche Bank AG

rated “BB”. 13% of the basket is rated “B” and this is one issuer, Venezuela. So the country
with the biggest weight in the index is also the country with the lowest rating. While
Venezuela is clearly a high risk country with 13% weight in the index, the remaining countries
are clearly more solid (for more details on the “MSCI USA TRN” ETF see ETF: Ideas and
Flows, 25 November 2009).
“db x-trackers Currency valuation” ETF 20% weight
In currency markets the majority of the participants are “liquidity seekers”. “Profit seekers”
are a minority in currency markets and can generate returns on the expense of the “liquidity
seekers”. Profit-seekers can generate returns by buying “under-valued” currencies and
shorting “over-valued” currencies. A widely used measure to determine “under-valued” and
“over-valued” valuation for currencies is the concept of “Purchasing Power Parity” where
“fair” exchange rates are calculated by comparing the prices of a basket of goods in different
countries. The ETF “db x-trackers Currency valuation” buys each quarter the three currencies
with the “lowest” valuation out of the universe of the G10 currencies and sells the three
currencies with the “highest” valuation using the PPP concept. In addition, the correlation to
equities and bonds is very low and therefore the currency valuation index helps to diversify
our ETF portfolio. The index is currently long in the US Dollar, New Zealand Dollar, and the
British Pound whereas the index is short in the Swiss Franc, Swedish Krona and the
Norwegian Krona. Risks to the investment include that currencies movements become less
rational again. Especially increased uncertainty about the economic development could
trigger a flight back into expensive currencies like the Swiss Franc (for more details on the
“db x-trackers Currency valuation” ETF see ETF: Ideas and Flows,12 June 2009).
Trading portfolio
We have kept the portfolio unchanged this time. Earlier we bought the “Emerging Markets
Liquid Eurobond Euro Index” ETF with 10% weight and sold the “db x-trackers DJ Stoxx
Global Dividend 100 ETF”. The portfolio targets absolute return and has the EONIA index as
benchmark.