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Trade Insight March 2015

Blowing bubbles: will European QE create growth or inflate assets?


Executive Summary


March 2015 will see the start of the €1.1tn Quantitative Easing (QE) in Europe. Our research suggests that the effectiveness of this programme, which will run until September 2016, will be determined by how markets react. In the US and the UK QE has created a prolonged bull run in equity markets. In Japan, the drop in the value of the yen has failed to have much impact on exports and therefore little impact on growth. In none of the countries where QE has been implemented is there obvious evidence of reflation which was the European Central Bank’s primary goal.

Our forecasts for March 2015 show some fragile signs of recovery in Europe and, similarly, evidence that equities in particular will continue their bull run. We do not expect QE to have a sustained dampening effect on the value of the euro and we are expecting the Australian dollar’s value to increase against the US dollar.

We expect oil prices to increase and are confident that other commodity prices will increase as well during the course of the month. QE, it seems, is having a positive effect on sentiment at least.


Outlook for PMIs February/March 2015


The Trade Corridor Indices (TCIs) measure the trade flows of any one country and forecasts these forward using its proprietorial forecasting methodology. Each index is specific to the country it relates to in that the trade corridors and flows will differ for each country. The rate of change in the index is correlated with the Purchasing Managers’ Index (PMI) for that country.

The TCIs are based on actual data and, although they are highly correlated, are in no sense an alternative to the PMIs since the methodologies differ. PMIs, being survey-based, are sentiment indicators while the TCIs give an actual and a forecast indication of how underlying trade conditions, including trade finance, are moving. In other words, the TCIs provide a predictable and quantifiable view of how changes in the global economy are affecting trade at an individual country level. They are constructed as follows:

  • The correlation of a country’s top 500 trade corridors with that country’s Manufacturing PMI to create a trade corridor index associated with the PMIs/sentiment (TCI-S)
  • Correlation of the rate of change in that index (6 month moving average) with the Manufacturing PMI
  • The monthly change in the six-month moving average (positive change suggests PMIs will improve while negative suggests they will deteriorate)

We are expecting Europe to show mild signs of manufacturing growth, China’s manufacturing PMIs to stay broadly consistent with PMIs for the last few months and the US ISM PMI to fall back slightly. The trade outlook for Europe is bleak in 2015 and we do not expect the signs of recovery evidenced by the PMIs to be sustained into Q2.




Figure 1  |  PMI outlook, February 2015
Source  |  Delta Economics


Outlook risk

  • The above information is based on the PMI tickers as listed
  • The predictive capacity of the model is strong, but not perfect since they are based on correlations rather than causal relationships
  • Note – the correlations and values given are against the Tickers listed and not with the Flash PMIs, although the Flash PMIs follow similar patterns


Trade Corridor Index Asset Price Calls




The Delta Economics TCI-based asset management strategy takes the top 500 trade corridors (trade between two countries by sector) against and asset price. It creates an optimum corridor index of those trade corridors each month and has been tracking its performance over the past 21 months. This is a systematic model and assets are included in the portfolio if one of the following conditions is met:

  • The signal strength, which measures the percentage of trade corridors that are pointing to a long or short call: this must be higher than 95%
  • The signal strength is greater than 85% and the Information Ratio (which measures the performance of that optimum corridor relative to benchmark returns) is greater than 0.5 (indicating good or very good back-tested performance)
  • Where there is a signal strength of 100 and only one corridor in the index, the Information Ratio must be above 0.5

The returns across the portfolio reflect the accuracy of the calls only. They are not optimised in any way, do not include transactions costs and are based on an equally-weighted portfolio across the asset calls that conform to the conditions above. In February 2015 these paper returns were 2.5% suggesting that over the past 21 months, we have called the assets in a way that potentially produces an above-market performance of 1.3% per month.




Figure 2  |  TCI-A returns, June 2013-February 2015
Source  |  Delta Economics


The calls for March 2015 reflect underlying volatility in equity markets in particular with Information Ratios (IR) largely negative or mildly positive. This reflects the high volatility of volatility that is currently visible in markets. Where there are low, even negative IRs, or weak signal strengths our portfolio suggestions potentially have substantial downside risk attached to them.




Generally we are expecting prices to rise. The copper & steel calls are particularly strong continuing an upward trend for copper and reversing a downward trend for steel. The strong IR on oil suggests that prices may climb slightly although the signal strength is weak. However, indications of stronger demand in China and Asia towards the end of Q1 suggest that the downside risk may be offset by actual demand trends elsewhere.




Figure 3  |  Delta Economics TCI-A based strategy, commodity calls for March 2015
Source  |  Delta Economics analysis




The model is bullish on all equities for March 2015 but with varying degrees of confidence and strong downside risk (i.e. higher risk/return) on all. The negative Information Ratios indicate the underlying volatility in markets and the potential risk of a Black Swan event, such as an adverse reaction to QE in Europe which starts in March. However, QE in other countries has tended to boost equities and early indications during February suggest that this may well be the case for Europe too. Given that there is also mildly positive economic news from both the TCI-S and PMIs, a more optimistic position on equities seems sound.




 Figure 4  |  Delta Economics TCI-A based strategy, equity calls for March 2015
Source  |  Delta Economics analysis





The model is suggesting a reversal of a trend on the Euro to a more bullish position. The German parliament has ratified the extension of the Greek loan and this means that “Europe” could well be out of the news for a while. Our analysis suggests that currencies tend to strengthen at the outset of QE (as in UK, Japan and the US). Weakening Emerging Market currencies against USD signifies the uncertainty around the prospect of rate rise in the US. While, the close correlation between the Australian dollar and euro underpins our AUD call and suggests that there are improvements in economic fundamentals (such as Asia’s performance) that are driving these calls.




Figure 5  |  Delta Economics TCI-A based strategy, equity calls for March 2015
Source  |  Delta Economics analysis



Delta Economics Trade Insight March 2015  |  Author  |  Rebecca Harding  |  CEO Delta Economics