Buying Europe?

When FEZ came into the top 3 in my Seeking Alpha portfolio at the end of last week, I have to admit that I felt a little leery. After all, “the market” as defined by the mainstream financial press was still digesting the latest rehash of the slow motion market meltdown in Greek sovereign debt. Surely the system was wrong on this one.

But, when you look at the Euro Stoxx 50 components, the picture is not dire at all. Two-thirds of the index is concentrated in France (37%) and Germany (31%) (see info page here) and looking at the top holdings, these are mostly household names that will benefit from a global recovery. OK, not a hugely compelling story to get the pulse raising at this juncture in the market.

So grudgingly I swapped out of my DBB (Base Metals), which had not performed, and put the proceeds in FEZ (Europe Blue Chips) on Monday because I could not come up with a good reason to fight the system on this change. The result? From Monday close to Friday close, FEZ returned a none too shabby 4.5%.

The result is important for two reasons.

Firstly, the return was split evenly between index and foreign exchange returns. Over the four days, the index gained 2% while the change in the Euro/USD exchange rate accounted for 1.8% of the return. Forex moves are very hard to predict accurately but they are driven by investment flows and Central Bank reactions. And, as you can see in this small example, the result of their actions are reflected in the changing price and can have an important impact on returns. Is the Euro going up or is the US dollar just sinking to new lows? Probably more of the latter than the former as the US Treasury and FED talk about a strong US dollar but act as though they want to bring the value down. Does it matter? Yes, but by the time one has clarity, the market will be preparing for the next move.

Secondly, the move was not foreshadowed by some major research report or market buzz. If there was a table pounding report saying something like “Now is the Time to Buy into Euro Blue Chips”, I certainly missed it. If there was a big “Buy the Euro now” call, it did not make the mainstream financial press. The fact that these companies are soldiering on with the global recovery while their governments and Central Banks attempt to deal with the financial situation as best they can is just not very compelling financial news. It is much more exciting to concentrate on how the Greeks will default and how the True Finn party will manage to throw a wrench into any Europe wide solution.

What does this mean for users of the System?

While certainly not every switch will work out as well as DBB to FEZ did in just a few days, the purpose of the System is to provide an unemotional signal to help you keep your money working in the most promising corners of your investment universe. Sometimes, as in the case of Blue Chip Euro stocks, it is not immediately apparent. But the point of this post is that you need to let the System do its job. Often a move will happen in a market first and the analysis follows later. Waiting for everyone around you to confirm that a particular trade is a winner can be a good way to buy into a crowded trade at a high point. While we want to participate in trades for as long as there is decent momentum, we do not want to have the buy and sell decisions driven by emotions. Our very human need to travel within the safety of the crowd is one of the primary reasons why investors buy at high prices in a bullish euphoria and sell at depressed prices in a bearish funk. The point of investing is to make money…emotions just get in the way.

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