Implications Of The Euro-Dollar Cross
As noted, the most direct effects of diverging central bank policies are changes in currency exchange rates. In 2014, for instance, the ECB cut rates, while the U.S. held rates constant, leading to a drop in the euro-dollar exchange rate of nearly 12 percent.
The significant drop in the euro has quickly made goods and services from eurozone companies much more attractive relative to their U.S. counterparts.
In fact, since the euro was implemented in 1999, a more than 1 percent quarterly drop in the euro versus the dollar has, on average, led to a 2.5 percent increase in export growth over the next four quarters.
Based on the analysis above, we would expect eurozone exports to accelerate over the coming quarters, but we cannot simply buy a eurozone ETF without accounting for the euro depreciation in some way.
Luckily, there are a variety of ETFs—such as DBEU that I mentioned above—that allow us to either directly hedge against a weakening euro or have the hedge embedded into the ETF.
While many have predicted slight earnings adjustments due to currency shifts, the most recent earnings season proved just how much currency adjustments could move the bottom line.
Nearly 15 percent of the companies within the S&P 500 Index had foreign-currency adjustments that accounted for more than 10 percent of net income last year. This stark reality led many analysts to adjust expectations going forward, as currency implications have come to be seen as a meaningful driver going forward.
Upgrades were far more likely for international companies, while many firms within the U.S. received downgrades following 2014’s fourth-quarter earnings season. For example, European and Japanese companies have seen more upgrades (and fewer downgrades), over the past three months.
Get Specific With ETFs
As noted above, as currency-volatility continues to increase, it will be important to understand the geographic breakdown of a company’s revenue streams and how currency adjustments will flow through to the bottom line during upcoming earnings seasons.
ETFs offer an efficient “one-stop shop” for getting this type of exposure, even in previously difficult areas of the capital markets to access.
Those include funds focusing on emerging markets or on specific countries—all with a currency hedge. Such choices include:
- Deutsche X-trackers MSCI Emerging Markets Hedged Equity ETF (DBEM | C-69)
- Deutsche X-trackers MSCI Germany Hedged Equity ETF (DBGR | B-74)
- Deutsche X-trackers MSCI South Korea Hedged Equity ETF (DBKO | D-60)
Again, the takeaway is this: Central banks around the world are doing different things that are creating challenges and opportunities for U.S. investors.
Most of that is in the realm of dollar strength versus a number of currencies. As this dollar-strength trend plays out, it will be important for investors to look more carefully at how the opportunities grow more granular.
Horizon Investments is a global tactical ETF strategist and asset management firm focused on developing and managing ETF-based portfolios and mutual funds for advisors, institutions and individuals. The firm uses a proprietary investment process to build portfolios designed for three major investing life cycles: accumulation, protection and distribution. To learn more, visit www.horizoninvestments.com. Contact Horizon at 866-371-2399 FREE or at [email protected]. For a full listing of relevant disclosures, click here.