Matt Hougan’s Top 3 ETF Picks For 2014

January 02, 2014

Hougan’s top picks for 2014 are as varied as they are interesting.

The story of 2013 was U.S. large caps. In 2014, the tape will focus on Europe, Africa … and municipal bonds.

Before I get to my calls, however, I have to mention the calls of my colleagues, Dave Nadig and Paul Baiocchi.

One of the great things about having colleagues like Dave and Paul is that you can count on them coming to work each day. Why? Because their investment picks are so crazy you know they’re never going to retire.

Baiocchi’s “Top 5 ETFs” speak of a gambler’s optimism that is beautiful to behold but painful to experience. From the Indian rupee to lithium, Baiocchi has scavenged the edges of the ETF universe for Hail Mary investments that would frighten a Silicon Valley venture capitalist hopped up on speed.

The best of his picks, like the iShares MSCI Mexico Capped ETF (EWW | B-94), make all the sense in the world. But balanced against Mexico are choices like the Pimco 25+ Year Zero Coupon U.S. Treasury ETF (ZROZ | C-51).

I love contrarian investing, and I don’t rule out the possibility of interest rates retreating mildly in 2014: from 3 percent on the 10-year Treasury note to 2.5 percent, perhaps.

But incoming Federal Reserve Chair Janet Yellen possesses the same deflationary fears as the man she’s replacing, Ben Bernanke. She won’t let rates slip lower than that. The result gives ZROZ an uneven payoff profile: small upside and large downside if rates jump significantly. That’s not a trade for me.

Paul is a smart guy and a good analyst, but caveat emptor.

Nadig, meanwhile, highlights the Market Vectors Gold Miners (GDX | A-54) as one of his top picks for 2014. I’m intrigued by GDX. Since Jan. 1, 2008, the fund has fallen about 60 percent, while gold prices are up almost 40 percent. That doesn’t make sense.

At some point, GDX will bottom. But when? Goldman Sachs’ Jeff Currie sees gold going to $1,050/ounce in 2014, and if he’s right, GDX will continue to be punished.

GDX is a classic falling knife, and knives always fall further than you think. Wait until the fund bottoms and, again, caveat emptor.

So what do I like in 2014? Here are three picks for the New Year:

3) DB X-Trackers MSCI EAFE Hedged Equity Fund (DBEF | C–51)

I think the defining macro move of the next few years may be a slow but steady appreciation of the dollar against other developed-market currencies.

My reasoning is fairly simple: The Fed is ahead of most other developed-market central banks in its transition from a rate-cutting environment to a rate-raising paradigm. As its starts to taper quantitative easing and eventually starts to tighten short-term rates, interest rate differentials will put upward pressure on the dollar.

This is the near-consensus view on Wall Street right now, with firms like Bank of America calling for the dollar to reach $1.24 on the euro from its current $1.38. That’s a 10 percent move. (The lone contrarian on the dollar right now is Goldman Sachs, which sees the dollar moving to $1.40 on the euro.)

If the consensus is right, you want to shift your international holdings from traditional exposures to currency-hedged exposures en masse. DBEF gives you the same exposure as the popular iShares MSCI EAFE ETF (EFA | A-89) but hedges out the currency. A 10 percent move in the dollar will translate into roughly a 10 percent gain for DBEF versus EFA.

This trade is the opposite of Baiocchi’s ZROZ call. Even dollar bears like Goldman Sachs expect little movement from current levels. But dollar bulls see significant upside. Large upside and low downside? I’ll be moving the bulk of my international holdings into currency-hedged exposure in 2014.

DBEF, by the way, is a good fund. It’s cheap, with an expense ratio of 0.35 percent, or $35 for each $10,000 invested. It’s also well established, with more than $250 million in assets.

It should be traded with care, of course, as its spreads—0.27 percent or 7 cents/share—are a bit wider than we’d like. Still, DBEF is an “Opportunities Pick” in our ETF Analytics rating system.




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