We have only one remaining stock to cover in our FANG series: Alphabet Inc., the “G” in FANG (the stock was formerly known as Google Inc.). Seeing as Alphabet is due to release its 3Q earnings later in the week, I figured it was best to delay our assessment, so we can have the company’s current earnings at the ready to review.
Update: The numbers are in and my Alphabet Inc. (GOOG) stock analysis is live. Read it here.
Today, instead, I’d like to address the latest headlines out of Europe, and I will be introducing you to a particular ETF that may stand to benefit from the events soon to transpire involving the European Central Bank (ECB).
Unwinding The Stimulus
The ECB is in the process of rolling back aggressive stimulus efforts that have been in place now for about a decade.
No one anticipates severely hawkish, sudden moves, but there is currently widespread expectation that major cuts will be made to the ECB’s bond purchasing initiative. The program is a key component of the long-running stimulus program and was designed to help add liquidity to capital markets.
Estimates suggest that the ECB’s bond purchasing will be scaled down by 50 percent, from 60 billion euros per month to 30 billion euros per month. News of this move already appears to be influencing the euro in an upward direction.
When you have the ECB buying 60 billion euros’ worth of bonds, it creates a massive artificial demand.
When bond issuers (like corporations, municipalities, cities, and Euro-zone countries) have no shortage of demand, they can sell off bonds at lower interest rates. Selling off bonds at lower interest rates makes the capital obtained through bond sales cheaper, which encourages economic growth and expansion.
You can learn more about how bonds work here.
Once the ECB’s bond purchasing program is scaled back, these same bond-issuing entities will be forced to take more of their bonds to the open market in search of buyers, which will in turn force them to offer more attractive yields.
From the standpoint of investors seeking to make the most of their portfolio’s bond allocations, newly higher-yield European bonds will pose an enticing offer. But in order to purchase the bonds, one must have an adequate supply of the home currency—the euro.
Therefore, the rollback of the ECB’s bond-purchasing initiative may very well propel the current bullish movement of the euro to even greater heights.
Some economists suggest that the euro’s current valuation has already baked in the ECB’s anticipated stimulus rollback.
I disagree for two reasons:
In the case of the bond-buying rollback, I think that the policy must fully materialize before the euro will experience the full effect of the change.
There is too much uncertainty in play for perception alone to carry the euro to its maximum heights, especially given the upcoming meeting of the US Fed’s Open Market Committee, which will occur one week after the ECB meeting, and an unpredictable president (who has expressed little affection for a strong dollar) with pending personnel decisions to make at the Federal Reserve.
I believe there will be somewhat of a delay between the ECB’s rescinding of the bond-buying program, the issuing of higher-yield bonds, and the bond market’s recognition of new opportunities in Europe and the ensuing spike in demand for the euro.
The unfolding of this chain of events will take time, and again, as it materializes, the euro won’t have any choice but to go higher.
This brings me to the ETF I wanted to tell you about.
What I enjoy most about ETFs is that they can offer exposure to virtually any sector of the market, including foreign currencies. The CurrencyShares® Euro Trust ETF (NYSEARCA:FXE) is designed to emulate the value of the euro relative to the US dollar.
If the euro is destined to climb to the heights reached in 2013 or early 2014, then buying shares in the FXE ETF would be a profitable endeavor.
The graph below shows the performance of FXE from 2013 forward.
Click or tap to enlarge. Image from Google Finance. Google and its logo are trademarks of Google Inc. Used with Permission.
A return to 2013 valuations for the euro would entail only a 20 percent profit for ETF investors.
That may be a little too conservative for some of you, especially if you think your best available returns still lie in the stock market, which seems to be setting record highs day after day. For those of you who are bearish about the stock market, then trading out of some stocks and making a play like this one on the euro may be a decent insurance move.
For the more aggressive trader-types, euro futures contracts are available.
The futures market anticipates a modest increase in the euro through the first two quarters of 2018, nothing dramatic. The market is assuming (and not unreasonably so) that the bond purchasing program along with any increase in interest rates by the ECB will be gradual and dovish, so as to not send severe shocks to the economy.
Nevertheless, if you, like me, anticipate greater-than-expected upward movement of the euro, and you’re more of an aggressive investor/trader, then you can always go long by buying either a euro futures contract outright or a call option on a euro futures contract.
It’s riskier than the ETF play, but big profits may be at hand.
You can learn more about how options work here.
DISCLOSURE: At time of writing, I do not currently own any shares in the FXE ETF, but I am actively considering investing in it and may have purchased shares by the time you read this article.
I do not currently have any futures, options, or any other long positions on the euro. ClydeBank Media has no affiliation with CurrencyShares® or Guggenheim.
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This article is a part of our ongoing series that explores a different stock or fund each week. The information contained herein should not be construed as ‘financial advice’ and is presented as the opinion of the author.
ClydeBank Media does not offer financial investment services and has no ties to any of the funds presented in this list. Please see our full financial disclaimer regarding the information contained within this stock analysis. Always consult your financial adviser before making investment decisions.