WHY CURRENCIES EFFECT FOREIGN RETURNS -- RISING CURRENCIES ARE BOOSTING CANADIAN AND LATIN AMERICAN ETFS -- WHY A WEAKER DOLLAR COULD BOOST FOREIGN RETURNS

BRITAIN REGAINS LOST GROUND ... The purpose of this article is twofold. The first is to show that the British stock market (and Europe in general) has recovered from yesterday's early selloff. Chart 1 shows the London Financial Times Index (FTSE) through this morning. Yesterday's bomb attacks pushed the FTSE sharply lower initially. By the end of the British trading day, however, the FTSE had recovered more than half of its its early losses. In today's trading, it jumped 1.2% to close at 5220. That matches gains of 1% in Germany and 1.2% in France, and puts European stocks where they were before the bombings. The second goal is to explain again the effect of currency moves on foreign returns for American investors. Compare Charts 1 and 2. Believe it or not, they show the exact same market -- British stocks. Chart 1 shows the FTSE near a 52-week high. Chart 2 shows the UK iShares (EWU) testing support at the 200-day moving average. Chart 3 explains why they look so different.

Chart 1

Chart 2

Chart 3

FALLING POUND DIMINISHES DOLLAR RETURNS ... The reason Chart 1 looks so different from Chart 2 is due to the falling British Pound. Chart 1 shows the British stock market (FTSE), which has gained more than 7% so far this year. Chart 2 shows the United Kingdom iShares (EWU), which has lost 1.6% this year. The reason for that nearly 9% discrepancy is due solely to the 9% drop in the British pound. That's because the FTSE is priced in British pounds. That's the return a British investor gets. The UK ETF, however, is priced in U.S. dollars. That's the return American investors get when the British profits are converted from pounds to dollars. In other words, British investors did very well in the UK market in 2005, while American investors would have lost money in the same market. That's why American investors need to consider foreign currency trends when investing overseas. And that's why a rising dollar during 2005 has made American assets more attractive than European investments this year. The trick is to find a foreign stock market that's rising in conjunction with a rising currency. Like Canada and Latin America.

CANADA HAS RISING STOCKS AND CURRENCY ... The next two charts show the Canadian stock market (TSE) and Canadian iShares (EWC) rising together. While the TSE has hit a new 2005 high, the EWC is close to doing the same. The reason both are rising is due to a rising Canadian Dollar (Chart 6). The rising currency ensures that American investors will be able to keep most of the returns in the rising Canadian stock market. [Being a natural resource producer, Canada is also a way to play rising commodity price trends]. The same is true in Latin America.

Chart 4

Chart 5

Chart 6

LATIN AMERICAN ETFS BENEFIT FROM STRONG CURRENCIES ... The two Latin American ETFs shown below have two things going for them. One is that they're commodity exporters. The other this that they have strong local currencies. Latin American iShares (ILF) are trading at a new 2005 high while Mexico iShares are testing their highs. Compare the Mexico ETF in Chart 8 to the Mexican Bolsa in Chart 9. They're both rising together. That's due mainly to the fact that the Mexican peso has been rising against the dollar throughout most of 2005. That ensures that the Mexican ETF (quoted in dollars) is rising along with the Bolsa (quoted in pesos).

Chart 7

Chart 8

Chart 9

GLOBAL MARKETS ARE IN SUPPORT... The main point I'd like to make here is that the best way for American investors to gauge the relative attractiveness of foreign stocks is to track foreign ETFs. That's because the ETFs are quoted in U.S. Dollars and give a more accurate picture of how a foreign market looks from an American standpoint. Foreign ETFs not only tell us something about foreign stock trends, but also about currency trends. Which brings us to our next chart. Its the EAFE Index iShares (EFA). The EFA is the dollar-denominated version of the Europe Australia and Far East Index (EAFE). That's what a large part of the world looks like in U.S. Dollars. Notice that it's been falling since early March and is now in a potential support area near its 200-day moving average. The line below the chart is the U.S. Dollar Index. Notice their inverse correlation during 2005. The March peak in the EFA coincided with a dollar bottom. The fact that the EFA is now in support suggests to me that the dollar may be nearing a peak. A dollar peak would give a boost to foreign stock market ETFs -- and especially to those in places like Europe that have been hurt by a falling currency. The Dollar Index meanwhile has reached a potential resistance zone and is looking overbought.

Chart 10

ANOTHER LOOK AT THE DOLLAR ... Chart 11 shows that the Dollar Index has moved into a potential resistance zone ranging from 90 to 92 which were the highs hit during the spring and summer of 2004. The 9-week RSI is in overbought territory over 70. That suggests to me that the dollar rally might start to encounter tougher going in the 90-92 region. From a seasonal standpoint, it may also be worth nothing that both dollar rallies started at the beginning of 2004 and 2005. The biggest dollar decline last year started with a couple of peaks formed from late July to late August. The dollar then fell from Labor Day to the end of December. During the first half of 2005, a firmer dollar made U.S. investments more attractive to American investors. Any downturn in the dollar would reverse that process and make foreign investments more attractive. In the meantime, keep an eye on foreign ETFs. You'll find them on the Market Summary page under MSCI Shares International. One final note. We're talking about relative returns here. Strength in foreign markets is a good thing for our market. What happens in one part of the world effects another. The fact that Europe recovered so nicely this week is helping the U.S. market end the week on a strong note.

Chart 11