As Market Trends Reverse, Choices Loom

May 15, 2015

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Clayton Fresk, CFA, portfolio management analyst at Georgia-based Stadion Money Management.

 

For the first part of 2015, there were various markets that were trending strongly—both to the up and downside. However, over the past month, many of these trends have reversed course. Is this more of a temporary correction, or are we in the beginning of a new trend?

 

It’s always hard to tell, but it’s worth examining some of these shifting markets to get a better sense of what to expect. With that in mind, I’ll take a closer look at a few of these markets.

 

European Equities

During the first months of the year, European equity markets were on fire. From the beginning of the year through April 10, the EURO STOXX 50 Index was up 21.9 percent. By comparison, Japan’s Nikkei rose 14.9 percent and the S&P 500 Index in the U.S. edged up just 1.6 percent.

 

This strength was accompanied by continuing weakness in the euro, which through April 10 was down another 12.4 percent against the dollar, even after its value deteriorated through the latter half of 2014. Without hedging, investors would have experienced only one-third of the local market returns during this time frame. For example, the unhedged SPDR EURO STOXX 50 ETF (FEZ | A-77) has returned just 7.6 this year, compared with almost 22 percent for the local index.

 

It is no wonder that the use of currency-hedged ETFs exploded during these moves. Shares outstanding in ETFs such as the iShares Currency Hedged MSCI EMU ETF (HEZU | D-43) have increased by 17 times this year.

 

Changing Tide?

However, over the past month, these different pieces of the European markets have each moved in opposite directions. The EURO STOXX is off 3.6 percent after trading 6.5 percent through May 5, while the euro has bounced off the $1.05 level and is trading about 5.6 percent higher. Thus, the net effect for an unhedged investor over the past month is a positive 2.2 percent.

 

Does this mean the hedged trade is no longer viable?

 

That does not necessarily seem to be the case, as situations such as the Greece exit and the quantitative easing program by the European Central Bank may still have pressuring effects on the euro. However, the smooth ride that these markets experienced early in the year could be running its course. Both euro volatility and the VSTOXX (the European equivalent of the VIX) remain elevated, and that indicates we could see some choppiness in both markets forthcoming.

 

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