MorningWord 6/20/16: Eurotrash – $EUFN

by Dan June 20, 2016 11:30 am • Commentary

Thursday afternoon I took a quick look at the price action of European bank stocks, particularly Deutsche Bank (Bank Bounce?). In hindsight this seems like an obvious observation for the very near term:

DB has sort of been the poster-child for euro bank weakness. But today’s reversal off of all time lows might create a short term trading opportunity. Tragically the reason for the bounce was today’s news of the brutal murder of the Labour Party parliament member Jo Cox in the UK. She was outspoken in her favor of Britain remaining in the EU and given her history of humanitarian and charity work had been a voice for Syrian refugees in Parliament. Groups opposed to remaining have already promised to take a breather in the rhetoric following the murder. And with the referendum vote just around the corner on June 23rd, markets feel the remain vote will be more united. Because of all that, Europeans banks may continue to see a short squeeze.  It’s not my cup of tea to trade off of headlines like this, frankly it’s just tragic, but it is market moving and I wanted to lay out what’s going on.

For those of you who share my worldview on the bigger issues facing European banks, it’s important to be aware of these headlines and not press shorts at what could be an inflection point.

For you traders out there this all makes sense near term. And for those that like to ride long term trends, in this case that Euro banks have yet to have the blood-letting that ours had in 2008/09, bear market rallies can be fierce, causing one to question their thesis altogether.  The 10% rally in the Euro Stoxx Bank Index (SX7E) off of Thursday’s low might have some legs from here as sentiment got extremely poor for all the wrong reasons (Brexit), which even at its highest polling was probably never going to happen.

A relief rally back to the downtrend (that has been in place since late 2015) could be a great short entry. As to what comes after that is likely another gut punch for the sector in the form of greater monetary accommodation. That means lower yields and more debt going below the zero interest rate bound in the region:

SX7E 1 year chart from Bloomberg
SX7E 1 year chart from Bloomberg

When it comes to trading it’s best not to press shorts at extremes. I think it’s safe to say RiskReversal readers understand more nuanced and nimble views like what I said above on Euro banks. While I was not willing to play for a bounce from the long side, I did identify a desire to wait for an opportunity on the short side that fits my worldview.

Rather than focus on a single Euro bank stock, I would rather focus this bearish view with the etf EUFN, the iShares MSCI Europe Financial etf. It doesn’t have the concentration of the hardest hit names like CS, DB and UBS (that are clearly oversold) but broader exposure among non bank institutions:

EUFN 2 year chart from Bloomberg
EUFN 2 year chart from Bloomberg

While European banks are obviously at the epicenter of the Brexit speculation and most impacted by NIRP, U.S. bank stocks have clearly been adversely affected of late by both, but while they have not been hit as hard, the bounce since late last week of about 2.5% in the XLF is fairly anemic and also offers some opportunity on longer term short positions. We’ll have more to say about both ETFs as we get closer to the UK’s EU referendum on Thursday.