3 ETFs to Play the Dollar Surge
Tue Sep 16 2014
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3 ETFs to Play the Dollar Surge

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The US dollar has been on an uptrend in the wake of positive economic data and rising odds for a sooner-than-expected rate hike. The greenback jumped to a 14-month high against a basket of major currencies last week.

The dollar’s advance against other major developed markets’ currencies has been aided by the divergence in monetary policies. While the Fed is winding down the QE and is expected to start raising rates sometime next year, central banks in the Euro-zone and Japan are still struggling to stimulate their economies by stepping up stimulus. (Read: 3 Ultra Cheap ETFs for long term outperformance)

How to benefit from a Strong Dollar

Currency ETFs appear to be the easiest way to play the greenback’s surge. Investors could consider US dollar ETFs PowerShares DB US Dollar Bullish Fund (UUP – ETF report) and WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU) or short Euro/ Yen ETFs ProShares Ultrashort Euro (EUO) and Ultrashort Yen (YCS). However, they should remember that currency ETFs are generally more expensive than equity ETFs, less liquid and also more volatile. (Read: Inside US dollar ETFs, will the run continue?)

There is another great way to play the dollar’s surge—investing in export oriented companies that benefit from a strong dollar. Large multinationals in Europe and Japan that derive a major proportion of their revenues from exports could be excellent bets on the US dollar. Further, home-gown factors in these regions are likely to help stocks of these exporters, while driving down the currencies. In such an environment, currency hedged ETFs—providing exposure to stocks while hedging the currency risk—are worth a look.

Japan—Play the Inverse Correlation between Nikkei and Yen

Japan is primarily an export oriented economy and thus its stock market usually displays a negative correlation with the yen. A weaker currency makes Japanese exports more competitive and thus as the dollar strengthens against the yen, stocks of Japanese exporters go up.

With the launch of “Abenomics”, Japanese stocks surged and the currency tumbled and thus the currency hedged ETFs had a spectacular performance last year. Japanese stocks did not do well earlier this year the economy shrank 7.1% annualized in the second quarter, mainly due to sales tax hike. (Read: Power your portfolio with these 3 Energy ETFs)

The authorities there have recently indicated that they are prepared to further ease monetary policy or take other measures to stimulate the struggling economy. The yen has been weakening against the dollar of late—touching its six-year low–and that trend is expected to continue in the coming months.

Another reason to be bullish on Japanese stocks is the rising profitability of Japanese companies. Corporate profits have reached their highest level since the financial crisis but the stock index still looks cheap at 14.6 times earnings.

WisdomTree Japan Hedged Equity Fund (DXJ – ETF report) is an excellent way to profit from this trend. Top holdings include well known Japanese exporters Toyota, Mitsubishi, Nissan and Honda. It charges an expense ratio of 0.48%. Another great ETF worth a look is Deutsche X-Trackers MSCI Japan Hedged ETF (DBJP – ETF report), which follows a similar strategy and is also slightly cheaper, with an expense ratio of 0.45%.

Europe—European exporters benefit the most from ECB policy measures

Earlier this month, the ECB lowered its main lending rate by 0.10% to a new record low of 0.05%. They also announced a program to purchase asset-backed securities and covered bank bonds. These measures are targeted at the deflationary threat that the region has been facing.

After the surprise move, European stocks surged to their six-year highs while the currency sank. With the Fed tapering its QE and the ECB continuing on its easing path and possibly starting a full-fledged QE (purchase of government bonds) sometime in the coming months, money is likely to flow into European equities.

While in the past few years European stocks and the Euro displayed a positive correlation as investors were worried about the prospects of the Euro-zone, the correlation has turned negative of late with bolder and likely more effective policies from the ECB. European exporters’ stocks look particularly attractive in this scenario.

The WisdomTree Europe Hedged Equity Fund (HEDJ – ETF report) tracks the largest dividend-paying Euro-zone companies with a minimum market capitalization of $ 1 billion and deriving least 50% of revenues from outside Europe. These exports focused companies are expected to well with additional stimulus and a weakening Euro.. Some of the very well-known large European companies with multinational operations like Anheuser-Busch, Unilever, and Siemens are among the top holdings.

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