A Macro Relative Value Play Made Easy
Although most of the
developed world’s equity markets and economies generally move in the same
direction (due to growing commercial/trade interdependence), their
rates of growth/atrophy tend to differ as a result of secular factors. These
differences give investors the opportunity to make relative value plays* between
two economies in question and can be done via bonds, equities or currencies.
The current differences between the European and
US economies are substantial enough that the US stock market should comfortably
outperform Europe’s for the foreseeable future, giving investors the
opportunity to potentially profit through a relative value play. This can be
done through ishares, which like like regular stocks do.
Europe : IEVÂ vs. US : IVV
Differences in monetary policy
In an effort to spur economic growth, the US
federal reserve has been very accommodative in its monetary policy, lowering the
Fed Funds rate rate to current 1.25%. This has provided businesses and
individuals with cheaper borrowing costs, by lowering corporate bond yields and
mortgage rates. By contrast, the European Central Bank, who’s primary objective
is to control inflation, has been more reactive than preemptive and far less
accommodative. As a result, Euro area short refi. rates are at 2.50 %–much
higher than where they should be.
Differences in labor
More flexible American labor gives US
businesses the cost-effective option of using temporary or contract workers
during the nascent phase of an economic recovery. Their European counterparts,
however, must commit to more expensive and less flexible labor guidelines that
smother economic recoveries since they will neither hire new workers nor can
they hire temporary ones.. Â
Differences in fiscal policy
In addition to the more accommodative monetary
policy, the US also has a more stimulatory fiscal policy. Congress is now voting
on a tax elimination plan that at the very least will total $350 billion, which
should enable American consumers to keep spending and demand growing.
The above mentioned differences were evident in
today’s release of first quarter negative GDP numbers for Germany (-.2), Holland
(-.3) and Italy (-.1) compared US GDP growth during the same period was 1.6%.
* Relative value plays are also known as pairs
trades by equity investors who find fundamental differences between two
companies in the same sector and buy the stronger company while simultaneously
short selling the weaker one. These strategies tend to be less volatile than
outright buying or shorting financial instruments since the two assets have a
high correlation.Â