Tuesday, March 24, 2009

Robert Hsu and EFU

February 11th 2009
Europe in Deep Recession
Similar to the situation in Japan, Europe's economic problems are rooted in its shrinking workforce, which is due to its structural demographic problems. There are high numbers of elderly people in the region, and the birth rates in Western European countries are very low. Because of this, there are not enough people entering the workforce to make up for the amount of people retiring. This has put a drag on the region's economic growth, and I look for this trend to continue.
Here's why: Europe is sliding into its worst recession since World War II. Europe's service and manufacturing industries contracted for eight months straight, and confidence in the economic outlook fell to a record low. These contractions have resulted in a low-ball official 7.8% unemployment rate, which could jump to double digits this year.
In addition, Germany -- Europe's largest economy -- may have contracted as much as 2% in the fourth quarter of last year, which would be the biggest quarterly contraction since 1987. Plus, the euro may shrink over 2% this year.
Despite all of these negative developments in Europe's economy, the European Central Bank (ECB) has been very reluctant to cut interest rates. Right now, the interest rate is steady at 2%, and the ECB has shown no indications that it will cut rates any time soon. Unfortunately, its wait-and-see approach is not acting fast enough to protect the economy. As a result of this, I believe Europe's economy will not recover until after the U.S. does, giving us enough reason to invest in an inverse ETF that's shorting the region.
New Buy: ProShares UltraShort MSCI EAFE
So this week, I recommend shorting European stocks by buying an ETF -- ProShares UltraShort MSCI EAFE (NYSE:
EFU). EFU allows us to short stock indexes by buying regular stock shares. It is also easier to trade, as it eliminates a lot of the risk involved in typical short selling.
EFU shorts the benchmark of the MSCI EAFE (Europe, Australasia, Japan) Index, which represents the developed markets outside of North America. The MSCI EAFE Index consists of 21 developed market country indexes, including the United Kingdom (20%), France (11%), Germany (9%) and Switzerland (8%). And in all, European companies make up two-thirds of the index.
EFU tracks daily investment results that correspond to twice the inverse of the daily performance of the MSCI EAFE Index. So this means that EFU should gain about twice as much, on a percentage basis, as any daily decrease in the MSCI EAFE Index. So if, for example, we use 5% of our allocation to EFU, our net equity exposure would go down by 10% without a lot of turnover.
Therefore, I want you to buy EFU under $104. I expect it to hit $120, giving us at least a 15% return in this trade.
March 11th 2009
ProShares UltraShort MSCI EAFE (NYSE: EFU) shares dropped in trading yesterday as European stocks advanced, pushing the Dow Jones Stoxx 600 index to its biggest gain in three months. This was the bounce that I have been expecting, and it may last a few days. But, as you know, I'm still expecting the European economy to struggle this year, and EFU is one of the best ways to take advantage of this nation's weakness. So I recommend that you take advantage of the drop in share price and buy EFU under $135.
March 23rd 2009

Sell ProShares UltraShort MSCI EAFE (NYSE: EFU)
If you recall from mid-February when the recent U.S. stimulus plan was proposed, many investors were on edge. But not just about if the stimulus would work -- also about the vagueness of Treasury Secretary Timothy Geithner's explanation of a planned rescue package. Geithner said that more details would come in the following weeks, but that was no comfort to already anxious investors.
So after weeks of indecisive posturing, Geithner finally unveiled the Treasury Department's plan today. And fortunately, the plan is set to help banks unload troubled assets and help unfreeze credit markets.
I have told you before that the best way to resolve the bad debt crisis is to let the government create incentives for private sector investors to buy toxic assets from financial institutions. I have said that if the Treasury is willing to guarantee against potential downside risk and/or allow tax incentives for investors, private equity funds, and hedge funds that other investors would step up and buy some of this debt. I think this approach is superior to the Treasury buying these assets directly or nationalizing the banks, mostly because the U.S. government is simply not in the business of running banks or managing bond funds. And fortunately, Geithner agrees.
According to the plan, the Treasury would lend $75 billion to $100 billion to provide leverage and guarantees for private investors. The FDIC will insure most of the deal. It will leverage private funds at a six-to-one debt-to-equity ratio, while the Treasury Department will finance half of the remaining balance. Therefore, private investors will only have to put up about 7% of the deal in upfront cash. These factors will likely entice some investors to participate. And I think if the Treasury can offer tax benefits that the deal would be even more attractive.
Even though this plan came a little late, it is the kind of leadership and action the banking system needs from the Treasury. Money is not enough to fix every financial problem, but this plan shows that the Treasury is willing to do whatever is necessary to take out toxic assets.
And the Treasury's plan makes me even more confident that we are seeing the beginning of a bottoming process in financial stocks. I think that this plan, when combined with the Fed's quantitative easing, the FASB's willingness to modify mark-to-market accounting and the SEC's consideration to bring back the "uptick rule" on shorting, may finally break the deadly downward spiral in financial assets that started last October.
Today's action is very bullish for stock investors everywhere. The resurgence of liquidity in the U.S. system will make it easier for debtors everywhere to refinance their loans, and prevent a global economic meltdown. In addition, this will lift global stocks everywhere and cause the market to move higher. Without U.S. financial stocks dragging on the global market, Asian stocks led by Chinese shares can finally move up. And in Europe, these plans will improve global liquidity, since much of the toxic assets held by European banks are U.S. debt..
I look for the European economy to improve due to this increased liquidity. While this is good news for the European economy, it is negative news for our holding in ProShares UltraShort MSCI EAFE (NYSE:
EFU). We originally bought EFU to profit from the dire economic scene in Europe, But since this will be seeing brighter days, I recommend that we get out of this investment. So let's cut our loss and sell our position in EFU.

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