TIB: Today I Bought (and Sold) - An Investors Journal #15 - Danish Banks and European Interest Rates

Who would have guessed that Danske Bank would pass its pre-GFC high? Time to test rotation into some of the other Danish Banks and to sell more European interest rate futures.

Bought

Jyske Bank (JYSK.CO): My investing coach identified that a few Danish Banks were popping up on his investing screen. I already own Danske Bank in one of my portfolios. I did a review of the whole sector to decide whether to add more. Starting point was to screen all the Danish Banks with a Price to Book Value (PB) ratio of less than 1 [means: the market thinks the stock is worth less than the book value of their assets]. Denmark has a few big banks and lots of little banks - I remember that from the time I worked there in the 1980's. So I sorted the list from largest to smallest.

Used the free screener at http://markets.ft.com

Three things come to my attention.

1. Danske Bank is not on the list which means it has PB greater than 1
2. The largest on the list Jyske Bank is 15 times bigger than the next one down
3. Only 4 have a market capitalisation greater than £100 million.

Now to the charts. Danske Bank is trading 63% above the pre GFC level and is trading 13% above the level my fund manager added it to my portfolio. If I can find that this is outperforming relative to other Danish Banks, I will sell this and switch.

The next chart shows relative performance between Danske Bank (black bars) and Jyske Bank (blue line). It is a percentage chart which starts from 2009. You will see on the right axis that Danske Bank is +64.31% and Jyske Bank is at 40%. That was enough for me to make the switch. As you look back over this chart you will see that these two banks have run hand-in-hand most of the time. I am expecting the lines to converge again.

There is a key question left unasked. Why stay invested in Danish Banks when I have strong views about other undervalued European banks? The next chart adds in the relative performance of Commerzbank (CBK.DE) (orange line).

This is a further 60% behind Jyske Bank. I chose to stay invested in Danish Banks from the time I took over the portfolio because I like the fact that Denmark is not part of the monetary union even though it is part of the European Union. This makes its banking performance less correlated with other European Banks. Since June 2015, the Danish currency has appreciated 0.41% against the Euro - that is enough for me. Would I invest new money in Danish Banks? NO. I would invest in Commerzbank or Credit Suisse. They are still below pre-GFC levels and interest rates are rising.

Sold

Danske Bank (DANSK.CO). This is a stock I inherited from my fund manager when I took over the portfolio. At the time I took over the portfolio this was in a losing position. My fund manager misinterpreted the transfer instruction and sold the stock realizing the loss. I made them buy it back as I was convinced European Banks would recover more than they had lost in the GFC. I was right. Profit from the initial purchase price was 13% and 23% from the forced buyback price.

Euribor 3 Month Futures December 2020. This is a short position [means: I did not own the futures when I made the sale]. I am expecting European interest rates to rise and I will buy back this contract before expiry. These are newly listed futures - I am already short June 2020 futures. Interest rates rise when inflation rises. Inflation has been rising in Europe since early 2016 and passed prior highs in mid 2016. [Note: Euribor is European debt funded in Euros]

Data from http://www.tradingeconomics.com/euro-area/inflation-cpi

I sold these futures at a price of 99.76 which means that the market is expecting European short term interest rates to be less than 0.24% in December 2020. I think the market is wrong and wrong by quite some distance. I think this is so because I have seen different numbers playing out in the US markets. Inflation in the US has been rising since late 2015 and quite a bit more strongly in 2016 - i.e., a little sooner than in Europe (maybe a quarter sooner).

Data from http://www.tradingeconomics.com/united-states/inflation-cpi

Eurodollar 3 month futures for December 2020 have been available on the markets for over a year. [Note: Eurodollar interest rates are for US debt funded in Euros] Price peaked in July 2016 at 98.6 and has now dropped to 97.56 (i.e., a whole 1% rise in interest rate expectations).

I fully expect European interest rates to drop by at least that 1 full percentage point by December 2020 - i.e., to get to 98.76 from the 99.76 (where the blue dotted line is on the chart below) I sold at. [Note: this is a leveraged trade - each contract is for €250,000 on which I have only to provide some margin. If I am wrong I will lose by a multiplier related to contract size (€2,500 per percentage point). My trade management strategy is to place stop losses above the 3 month swing highs. Starting a new contract is tricky as there is not much history. I will use the pricing from the June 2020 contracts]

I will not be surprised to see it go more and I have nearly 4 years to be right.

Expiring Options

No work on US options expiring on Janaury 20 - markets closed for Martin Luther King Day.

Currency Trades

No new currency trades - I try not to trade when US markets are closed.

Cautions: This is not financial advice. You need to consider your own financial position and take your own advice before you follow any of my ideas. The ideas for interest rates are advanced - do not copy them without taking proper advice. I do participate in an investing group - some of the ideas flow from there.

Images: I own the rights to use and edit the Buy Sell image. The inflation data images are copied from TradingEconomics.com - copyright ownership is included on the charts. All other images are created using my various trading and charting platforms. They are all my own work

January 16, 2017