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UK's Easy Money Policy Could Cause a Double-Digit Rally in This Fund
While the overwhelming narrative of late in the global markets has been the Federal Reserve's "taper" talk, not every central bank around the world is following the Ben Bernanke playbook. Last week, there was a meeting of the Bank of England (BOE) that proved that not all minds think alike when it comes to monetary policy and a continued commitment to easy money stimulus.
In his first meeting as governor of the Bank of England, former Bank of Canada governor Mark Carney stirred the pot a bit with a much more detailed statement of the normally terse BOE decision by the Monetary Policy Committee. When I say terse, I meant it, as the BOE's June press release was basically two sentences long.
The new Carney-led BOE came with a more detailed statement for July. It essentially signaled that the Bank of England will begin using forward guidance as another tool to keep interest rates low. Global traders I've spoken with during the past couple of days have told me that they suspect that this new willingness to signal BOE intentions by Carney will act like a bid higher in UK-based equities.
I think it also serves as a reminder that the BOE still is relevant, and that it should be considered carefully as a driver of equities in the United Kingdom. Moreover, it's important to note that the BOE has been much more aggressive with its own version of quantitative easing than, say, the European Central Bank.
Unfortunately for the UK, because it's not a member of the European Union, it can't rely on strong countries such as Germany to soften the economic blow dealt to the global economy from the Great Recession. The result here is UK economic growth that has remained sluggish by comparison with the EU.
This situation, however, could soon change, and here's why:
As we've seen in the United States, quantitative easing in all of its various forms has finally started to boost key market segments such as jobs and housing. And while the recovery here hasn't been robust, we do appear to be on an upward trajectory. Also, since quantitative easing has been full throttle over the past three years, the S&P 500 has spiked about 55%.
In terms of economic data in the UK, things also have been ticking higher. For example, the Halifax Home Price Index is up, as are the June PMI services and manufacturing metrics. Retail sales in the UK also have been improving at a healthy pace. But the key metric here is GDP, and on that front the UK remains essentially stagnant.
The smart money is betting that Carney is going to be a dove on monetary policy and continue the BOE's asset purchasing program for some time in an effort to juice up those GDP numbers. By all readings, Carney is committed to not letting the nascent progress made in the UK economy stall. That means we can expect more QE from the BOE, and that means we are likely to see a rebound in the biggest stocks pegged to the region's fate.
Taking advantage of those stocks is easy via the iShares MSCI United Kingdom Index (NYSE: EWU).
This fund is pegged to the MSCI United Kingdom Index, which is comprised of the biggest and most heavily traded UK-based companies. Here we are talking about stalwarts such as HSBC Holdings (NYSE: HBC-PA), Vodafone (NASDAQ: VOD), BP (NYSE: BP), GlaxoSmithKline (NYSE: GSK) and Royal Dutch Shell (NYSE: RDS-B).
The chart of EWU shows the big move higher in the fund throughout much of the year. EWU came back down below key technical levels in June, but since falling to its most-recent low, we've seen shares stage a nice rally that's brought it back above the 200-day moving average.
I suspect we could easily see EWU rally another 10% from current levels, which would push the fund to new highs at $19.90. I also suspect that this rally will hold here, but if it doesn't, you will want to set a pretty tight stop-loss around 3% below current levels. I believe the risk-reward ratio on this momentum trade is heavily in the buyer's favor here, and that means some strong upside potential with modest downside.
One thing we've learned over the past few years is that when a central bank puts the QE pedal to the metal, the country's market tends to take off. This is what's happening right now in the UK, and that's why you want to own EWU.
Recommended Trade Setup:
-- Buy EWU at the market price
-- Set stop-loss at $17.50, approximately 3% below the current price
-- Set initial price target at $19.90 for a potential 10% gain in 4-6 weeks