Trade Idea: Draghi's Dilemma Says Short MSCI Germany ETF EWG. Part 1

10/03/2018 12:26 pm EST

Focus: ETFS

Landon Whaley

Editor, Gravitational Edge

In this week’s Macro Theme, we review “Draghi’s Dilemma,” which is the macro theme we’ve been using since March to short German and French equities. We focus on economic developments in Germany since our last update in early August, writes Landon Whaley from MoneyShow.

There’s been one key development over that time that has added kerosene to an already bearish fire for German equities and their U.S.-listed ETF, the iShares MSCI Germany ETF (EWG).

Fundamental Gravity says what?

Two chief variables impact the risk and return of asset prices: economic conditions and how central banks respond to those conditions. Together, these variables drive what we call an economy’s Fundamental Gravity.

The deluge of data out of Germany (and the eurozone) over the last six weeks has gone from bad to worse.

German export growth slowed to +4.5% in July, continuing the downtrend which began after growth peaked in December 2017 at +9.9%.

German industrial production has slowed for three consecutive months (and four of the last six months) and is now sitting at the lowest level in over two years.

German Manufacturing PMI has slowed for two consecutive months and in eight of the last nine months.

German retail sales slowed again in July to a meager +0.8%. Keep in mind that this growth rate, which is barely above outright contraction, comes after sales growth peaked at +5.0% 12 months ago. German consumption is in one heck of a year-long bear market!


It’s not just the data telling you that things are bad; the people are singing the same growth-slowing tune.

The German ZEW Economic Sentiment Index peaked in January and has been outright negative for six consecutive months. The last time ZEW readings were this negative, the German economy was on the brink of a recession.

And it’s not just the German economy that people are pessimistic about; the European Commission Economic Confidence Index and the EC’s Consumer Confidence Index have both now slowed to the lowest readings in 13 and 15 months, respectively.

In addition to the slowing growth data and further deterioration in sentiment, there is another trend taking hold that should have investors on high alert: German inflation.

After meandering between +1.49% and +1.56% for the better part of the last 12 months, Germany’s core inflation rate has just slowed for three consecutive months. Consumer inflation has shown a similar trend, despite heating up briefly in Q2 2018.

German CPI slowed for three consecutive months from November 2017 to February 2018, then jumped from +1.4% to +2.2% between February and May. Since peaking at +2.2%, CPI has slowed in two of the last three months. Draghi himself weighed in on the topic of inflation but spoke out of both sides of his mouth. While he acknowledged that "measures of underlying inflation remain generally muted," he went on to say that "uncertainty around inflation outlook is receding" and that he expects "underlying inflation to pick up toward end of year."

This guy doesn’t know if inflation is coming or going, and we’re happy to fade Super Mario’s pro-inflation perspective because the data tells us to.

The Fundamental Gravity bottom line is that the renewed downtrend in the rate of inflation adds another layer of bearishness to the German equity market. From a Fundamental Gravity perspective, it doesn’t get more bearish for German equities than when growth and inflation are slowing together.

During this type of FG4 environment, EWG typically averages a -1.9% quarterly return with an average quarterly drawdown of -12.6%. In addition, it posts positive three-month returns 48% of the time.

Draghi’s Dilemma and Shorting MSCI Germany ETF EWG. Part 2

This Friday, October 5, we will release part 2 of this commentary, which is where we will dig in to the other two critical forces, or gravities, that are currently impacting German equities: Quantitative and Behavioral. We will also provide a detailed game plan for trading EWG.

If you can’t wait the 48 hours to get the complete picture for this macro theme and the accompanying trade details, please email us at with the subject line “Draghi’s Dilemma – Part 2.”

We will provide you with the complete macro theme breakdown as well as sign you up to participate in an eight-week free trial of our research offering, which consists of three weekly reports: Gravitational Edge, The 358, and The Weekender.



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