JAPAN AND EUROPE LEAD EAFE ISHARES HIGHER -- GERMANY, FRANCE, AND THE UK LEAD EUROPE -- HOW TO HEDGE GERMAN ISHARES AGAINST WEAK EURO -- JAPANESE STOCKS NEAR 15-YEAR HIGH -- HEDGING AGAINST THE FALLING YEN HAS BEEN A GOOD IDEA
EAFE ISHARES TURN UP ... Foreign stocks continue to show signs of strength. Chart 1 shows EAFE iShares (EFA) trading above its 200-day moving average after recently exceeding its late November peak. At the start of February, it also broke a declining resistance line drawn over June/September/November highs. That means that stocks in Europe, Australasia, and the Far East are back in uptrends. In addition, foreign shares are doing better during 2015 than U.S. stocks. The solid blue area shows the EAFE/S&P 500 ratio turning up at the start of the year for the first time since last spring. In fact, EAFE iShares have outpaced the S&P 500 a three to one margin this year (6.1% for EAFE versus 1.8% for the SPX). That raises questions for American investors. For one thing, it suggests that investors might want to do more rotating from U.S. to foreign shares. It also raises a question, however, about how to deal with currency considerations. We'll come back to that later. Let's see where most of that foreign strength is coming from.
(click to view a live version of this chart)
Chart 1
EUROPEAN LEADERS... Three of the biggest European stock markets appear to be bottoming. Germany is the strongest. Chart 2 shows Germany iShares (EWG) exceeding its 200-day average and its fourth quarter high. Chart 3 shows France iShares (EWQ) nearing a test of its 200-day line after clearing its fourth quarter high. [Other continental leaders include Switzerland and the Netherlands]. European strength isn't limited to the continent. Chart 4 shows United Kingdom iShares (EWU) challenging fourth quarter high near 19.00. An upside breakout appears likely. The EWU is also gaining strength from a slightly stronger British Pound (red line). What's impressive about the gains in the EWG and EWQ is that they're not getting much help form the Euro. The green line in Charts 2 and 3 show modest stabilization in the Euro, but no convincing signs of a bottom. That creates a headwind for foreign ETFs quoted in dollars. All three charts, however, suggest that rising European stocks are beginning to overcome the negative effects of weaker European currencies.
(click to view a live version of this chart)
Chart 2
(click to view a live version of this chart)
Chart 3
(click to view a live version of this chart)
Chart 4
TO HEDGE OR NOT... I've written several articles about the need for foreign buyers in European stocks to hedge against the weaker Euro (via the WisdomTree Europe Hedged Equity Fund [HEDJ]. Today I'm going to narrow that comparison to Europe's largest and strongest market, which is Germany. Chart 5 compares Germany iShares (EWG) to the Wisdom Tree Germany Hedged Equity Fund (DXGE). The DXGE is doing much better. Since July, the DXGE has gained 6% versus a -6% loss in the EWG. [The DXGE is up 12% during 2015 versus a 6% gain in the EWG]. That difference is entirely due to the weaker Euro. At the moment, both German ETFs are rising. But there's a choice to make. A bet on the green line is a bet against a stronger Euro. A bet on the blue line is a bet on the Euro. Until the Euro shows definite signs of a bottom, however, the longer range trend appears to favor hedging against it with the DXGE or the HEDJ.
(click to view a live version of this chart)
Chart 5
EUROPE IS DOING BETTER THAN THE U.S. ... One of the biggest questions facing global investors is whether it's time to trim some U.S. stock holdings and rotate into cheaper foreign shares. Technical readings appear to favor more foreign holdings. Two of the best choices are Europe and Japan. Europe first. Chart 7 plots a relative strength "ratio" of the the Stoxx Europe 600 index divided by the S&P 500. To the bottom right, the ratio has jumped to the highest level in nearly a year, and has broken a five-year resistance line. [Since January 1, the STOXX has gained 11% versus a 2% gain for the SPX]. That jump in the relative strength ratio supports rotating some money from the states into Europe. But be sure to hedge the currency risk. The same analysis applies to Japan.
(click to view a live version of this chart)
Chart 6
LAND OF RISING STOCKS ... Since the end of 2012, Japan stocks have gone from one of the weakest to one of the strongest markets in the world. The monthly bars in Chart 7 show the Tokyo Nikkei Index (plotted through Wednesday) challenging its 2007 intra-day peak at 18300. [Today's higher close at 18264 was actually the highest close since 2000]. Assuming that upside breakout continues, that makes Japan a leading candidate for foreign funds (as we pointed out several times over the last two years). And it's doing better than most other markets. The solid orange area plots a "ratio" of the Nikkei divided by the Dow Jones Global Stock Index ($DJW). That relative strength ratio has been rising since the start of 2013 . Since the start of 2013, the Nikkei has risen 75% versus a 27% gain in global stocks. The S&P 500 rose 47%. But there's a catch. The strong performance of Japanese stocks has come at the expense of a falling yen. There again, it has been necessary to use a vehicle that hedges out the negative impact of a weaker yen.
(click to view a live version of this chart)
Chart 7
NEED TO HEDGE FALLING YEN... Chart 8 shows why it's been necessary for foreign investors buying Japanese stocks to hedge out the falling yen. The green line shows the WisdomTree Japan Hedged Equity Fund (DXJ) rising much faster than Japan iShares (orange line) since the fourth quarter of 2012. That was when Japanese stocks turned up and the yen plunged (in anticipation of Abenomics and a battle against deflation). Since October 2012, the DXJ has gained 93% versus a 38% jump in the EWJ. That huge difference was due primarily to -34% drop in the value of the yen. [The Nikkei gained 105%]. Over the last year, the DXJ again outpaced the EWJ by a 16% to 2% margin, as the yen continued to drop. [Readers of these messages will remember several past articles on the merits of the DXJ]. But that's the past. Since the start of 2015, a more stable yen has enabled the EWJ to outpace the DXJ by a 9% to 8% margin. In Japan as in Europe, which ETF you choose depends on your view of the currency. A weaker yen favors the WisdomTree hedged fund, while a stronger yen favors Japan iShares. Until the yen proves that it's bottomed, the longer range trend appears to favor the DXJ. [Both Japanese ETFs are hitting new highs today]. So there are two messages here. One is that Japan remains a leading candidate for foreign investors looking to diversify away from the U.S. (along with Europe). A second message is the need to choose the right ETFs to protect against any foreign currency losses.
