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Short Europe with These Inverse ETFs

Sweta Killa

Investing in European equity market turned out of investors’ favor in recent weeks primarily on a flurry of negative economic indicators and bitter relationship between Russia and the West. Weak corporate earnings, Portuguese banking woes as well as escalating violence in Iraq, Ukraine and the Gaza Strip continue to weigh upon the growth of European economy (read: Where Will Europe ETFs Go After Portugal Banking Woes?).

Economic and political issues have also pushed the euro down against the greenback. The second-most traded currency in the world dropped to an eight-month low in Tuesday trading. Further, an improving U.S. economic and accelerating job market are driving the dollar upward.

Stalling Economic Recovery

Despite the recent unprecedented European Central Bank’s (:ECB) stimulus, Europe is struggling to boost growth and inflation. This is especially true, as the Euro zone (18-nation bloc) is expected to grow a tepid 0.1% in the second quarter (data due to be released on Thursday) after 0.2% growth in the first thanks to ongoing deleveraging by the private sector, tight fiscal policy, restrictive credit conditions and high unemployment (read: 3 European ETFs to Buy After ECB Action).

Germany, the powerful engine and the largest economy of Europe, is now showing signs of faltering. German investor confidence, as depicted by ZEW, plunged to the lowest level in more than one and half years at 8.6 in August from 27.1 in July. As such, the economy is expected to show no growth in the second quarter compared with 0.8% in the first quarter due to the Ukraine crisis and tougher sanctions on Russia.

Apart from Germany, growth in most of the economies in the Euro zone remains weak and uneven. Italy, the third-largest economy, slips back into recession in the second quarter shrinking 0.2%, more than 0.1% contraction in the first quarter.

Euro zone inflation fell to a five-year low of 0.4% in July, miserably lower than the ECB target of 2%. Though unemployment slightly fell from 11.6% in May to 11.5% in June, it is still near a record high of 12%. All these macro data indicate heightened worries that Europe could enter a Japanese-style deflationary spiral.

Russia Import Ban to Hurt Growth

Russia has imposed a tit-for-tat ban on food imports for one-year from the Western countries, including Europe, in retaliation to sanctions imposed on it over the annexation of Ukraine. The move came after the West put tougher sanctions on the companies targeting the Russian energy, defense and financial sectors (read: Russian Food Import Ban Takes a Bite Out of These Agricultural ETFs).

The food embargo will likely hurt the fragile European recovery extensively, as the European Union (EU) is the second biggest exporter of food products to Russia, accounting for about €11.8 billion ($15.8 billion) of food to Russia. In fact, Russia buys 31.5% of its meat, 42.6% of its dairy products, and 32% of its vegetables from Europe, according to the Institute for Complex Strategic Studies (:ICSS).

Given these concerns and the gloomy outlook over the health of the economic growth, the appeal of Europe ETFs seems to be dulling. This would be especially true if exchange of trade sanctions continue to escalate leading to more bans on trade in European oil and natural gas industry.

As a result, investors who are bearish on Europe right now may want to consider a near-term short on the country and its currency. Fortunately, with the advent of ETFs, this is quite easy as there are many options for accomplishing this task. Below, we highlight those and some of the key differences between each:

Daily FTSE Europe Bear 3x Shares (EURZ)

This ETF seeks to deliver three times (3x or 300%) the inverse (opposite) daily performance of the FTSE Developed Europe Index. The benchmark measures the performance of the large and mid cap securities of the 17 developed market countries: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

The product is unpopular with AUM of $3.9 million while charges 95 bps in fees and expenses. It trades in paltry volumes of nearly 2,000 shares per day, suggesting additional cost in the form of a wide bid/ask spread. The fund gained 14.7% over the trailing one-month period.

ProShares Short Euro (EUFX)

This fund seeks to deliver the inverse return of the daily performance of euro versus the U.S. dollar. It is often overlooked by investors having just $16.3 million in its asset base while volume is light under 6,000 shares per day. It charges 95 bps in annual fees and added 1.8% in the same time period (see: all the Inverse Equity ETFs here).

ProShares UltraShort Euro ETF (EUO)

This fund seeks to deliver twice (2x or 200%) the inverse return of the daily performance of euro versus the U.S. dollar. It has attracted $458.2 million in its asset base and trades in solid volume of 537,000 shares per day. Expense ratio came in at 0.95%. The ETF added 3.5% over the last one month.

Market Vectors Double Short Euro ETN (DRR)

This ETF tracks the Double Short Euro Index, which is two-times leveraged. This means that 1% weakening of the euro relative to the U.S. dollar would increase the index value by 2% and vice versa.  

The fund has managed assets of $37 million so far in the year and trades in light volume of 4,000 shares a day. This suggest a wide bid/ask spread increasing the total cost for the product beyond the annual fees of 65 bps. The ETF is up 4.1% in the same period.

Bottom Line

As a caveat, investors should note that such products are extremely volatile and suitable only for short-term traders. Additionally, the daily rebalancing—when combined with leverage—may make these products deviate significantly from the expected long-term performance figures (read: 2 Great European ETFs to Buy in an Uncertain Market).

Still, for ETF investors who are bearish on the European equity market and its currency for the near term, either of the above products could make an interesting choice. Clearly, a near-term short could be intriguing for those with high-risk tolerance, and a belief that the “trend is your friend” in this corner of the investing world.

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