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Monday, July 05, 2021

Netherlands 25 – Europe 600 Consequences of a Hawkish Tilt

تم إعداد هذا المنشور من قبل سنشري للاستشارات

Netherlands 25 – Europe 600 Consequences of a...
Netherlands 25 – Europe 600 Consequences of a Hawkish Tilt

*Trading in financial markets carries risk and can result in loss of capital
*This performance is only observed with historical backtests and not traded by the company


The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and use of margin involves a significant risk of loss, which can exceed deposits. Please read the complete disclaimer carefully.

The yield curve started to flatten in the second quarter of 2014 and resulted in the outperformance of Tech sector, along defensive stocks such as utilities and healthcare. Sectors such as financials, energy and industrials performed poorly. US Federal Reserve Chairman Jerome Powell’s hawkish tilt on transitionary inflation has led to the flattening of the yield curve. Along with US treasury spreads narrowing, the Germany Bund (benchmark for European yields) spreads also narrowed during the same period.

Germany Bund 30 Yr & 5 Yr Spread ( Source : Bloomberg | Date : 23rd June 2021 ) Germany Bund 30 Yr & 5 Yr Spread ( Source : Bloomberg | Date : 23rd June 2021 )

A Multi-Month Trend

The latest economic forecasts released by the Fed in the FOMC meeting for the month of June 2021, 11 of 18 policymakers expected at least two interest rate hikes by the end of 2023. The prospect of those earlier-than-expected moves have soared short-term yields higher while keeping longer-duration yields subdued as market fears of out-of-control inflation subside.

Presently, the economy is expected to witness a similar wave like it did in 2014 and thus the tech dominated indices in the EU zone should fundamentally outperform the indices that are dominated by the financial sector. This could be a gradual and a multi-month trend.

In 2014, as the yield curve started to tumble, the Netherlands 25 Index rallied and outperformed the Europe 600. The ratio between the two indices increased from 1.1751 to 1.3442 as portrayed in the chart below.

Netherlands 25/Europe 600 ratio from 2014 to 2016 Netherlands 25/Europe 600 ratio from 2014 to 2016

The Pair Trading Strategy involves going long on Netherlands 25 increasing in value and simultaneously holding a short posi- tion on Europe 600.

Netherlands 25 has a significant allocation to technology sector that stands to benefit from the yield curve flattening since their valuations are based on the now lower discount rates while the Consumer Discretionary sector is anticipated to perform well with the reopening of the Europe and United States economy.

Whereas the Europe 600 is formulated of the Industrial sector, succeeded by the Financials. The banking sector will logically witness reduced net interest margins due to narrowing yield spreads in a flattening yield curve scenario. Additionally, the Industrial sector may foresee lower profit margins since a cap on inflation implies a cap on sales price.

On a Year-to-date basis, substantial money was pumped into the cyclical sectors which the Europe 600 is composed of, due to the reflation trade. On the anticipation that the yield curve would remain flattened, the banks and industrials would be aected the most as their profit potential would reduce. This could trigger a sector rotation (end of reflation trade) back to technology that the Netherlands 25 is constituted of.

Macro View on Holdings of Netherlands 25 & Europe 600

Netherlands 25 Sector Constituents

Sector € Market Cap (In Bln) Market Cap %
Information Technology 319.18 28.7%
Consumer Staples 216.17 19.4%
Consumer Discretionary 149.35 13.4%
Energy 130.19 11.7%
Industrials 92.77 8.3%
Materials 74.64 6.7%
Financials 68.58 6.2%
Health Care 38.97 3.5%
Communication Services 11.21 1.0%
Real Estate 11.11 1.0%
Total 1,112.17 100%

Date: 23rd June 2021
Source: Bloomberg

Europe 600 Sector Constituents

Sector € Market Cap (In Bln) Market Cap %
Industrials 5,530 20.7%
Financials 4,590 17.2%
Health Care 3,440 12.9%
Consumer Discretionary 3,040 11.4%
Consumer Staples 2,480 9.3%
Materials 1,830 6.9%
Information Technology 1,740 6.5%
Energy 1,240 4.6%
Communication Services 1,170 4.4%
Utilities 977 3.7%
Real Estate 664 2.5%
Total 26,701 100%

Date: 23rd June 2021
Source: Bloomberg

However, it is important to note that Trading pairs is not a risk-free strategy. The jeopardy comes when prices of the two securities move contrary to the positions taken resulting in losses. Thus, it is important to adhere to strict risk management rules when dealing with such adverse situations.

Disclaimer: Individual stocks in the index are subject to both weightage recalculation & recomposition risk. As a result, certain stocks may be added or removed from the index upon index recalculation. Consequently, the performance of the relative index may deviate from the one specified above.

Note: Trading Timings (Subject to Change) :
Netherlands 25 - 10.00-00.00 GMT+4
Europe 600 - 10.00-00.00 GMT+4

Risks and Assumptions for Back-tested trading strategies
The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
Unforeseen events can lead to variation in performance from the tested trading strategy.
The tested result has been computed with price feeds available from Bloomberg.
The testing environment has not considered transaction or any other costs.
Trading indicators used for the purpose of testing has been provided by Bloomberg.
The strategy might suffer from data mining fallacy, selection bias and backfill bias.

Data Source: Bloomberg
Date: 27/6/2021

Arun Leslie John
Chief Market Analyst

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