Timing Foreign Markets
Chapter 12: Timing Foreign Markets
Considering the Currency Effect
Whenever you invest in a foreign country, directly or indirectly, you should be aware of the effect of that country’s currency on your investment.
Generally, your foreign investments do better if the dollar is weak, as long as the investments are performing well, but the state of the currency of the country that you’re investing in is most important.
Figure 12-1 shows you a good example — the Australian Dollar (FXA, Currency Shares ETF, left) and the Australian stock market ETF (AUS, the NETS S&P/ASX 200 Index ETF, right).
Figure 12-1:
The con- nection between the Australian Dollar (left, FXA) and the Australia Index ETF (AUS, right).
Chart courtesy of StockCharts.com.
The circled portion of the FXA chart roughly corresponds to the downtrend in the AUS chart. Note that when the volatility in FXA started to become apparent, around May 19, 2008, AUS began to weaken. And even though FXA managed to make a new high, AUS never did confirm it, creating a significant technical divergence. This is an excellent example of what could happen to your foreign investments if the currency starts to weaken, and why you should keep an eye on both the investments and the currency.
When you’re timing foreign markets, watch for action in the underlying cur- rency. If the currency starts to strengthen or weaken, watch what the activity is doing to your ETF, as it’s going to have to work harder to give you potential gains because of the currency effects. If your ETF starts to weaken, either because the currency is too weak or too strong, it’s likely a signal that things are getting worse and that you may want to consider selling the ETF.
Figure 12-2 gives you a slightly different take on the theme and throws in another variable — interest rates. On the left you see the Brazil iShares ETF (EWZ) and on the right, the WisdomTree Dreyfus Brazil Real ETF (BZF). The circled portion of the EWZ chart corresponds to the time period depicted in the chart on the right. Note that as the currency (the real) rose, the stock market, as represented by EWZ, fell. Brazilian investors feared higher inter- est rates from Brazil’s central bank and sold stocks. But the currency rose because higher interest rates are generally positive for that country’s cur- rency. Watch both the stock market and the currency, and make your deci- sions based on the chart.
Figure 12-2:
Brazil iShares ETF (EWZ, left) shows a falling Brazilian stock mar- ket, and the Wisdom-
Tree Dreyfus Brazilian Real Fund (BZF, right) shows a ris- ing Brazilian
currency.
Chart courtesy of StockCharts.com.
Timing Foreign Markets
So what do you need to keep in mind when timing foreign markets? Aside from keeping tabs on the individual markets and the currencies, you need some timing vehicles. For most timers, ETFs and mutual funds are the best vehicles, although you can also own American Depository Receipts (ADRs) of individual stocks, or in some cases buy the listed shares of the company outright — many global companies are now listing their stocks on multiple exchanges simultaneously.
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ADRs are bundles of shares of foreign companies that trade on American exchanges, valued in dollars. You can buy them and sell them as you would any share of stock via your broker or online account.
Getting started
I like ETFs because they let me time the region, and I don’t have to worry about the particulars of any one stock. In most cases, an ETF that concen- trates on any one region of the world or specific country is built based on an index. The ETF’s price movements therefore represent the general action in that particular region of the world. You use it to trade the trend, not so much the details.
For the purposes of timing, I divide the world into a few separate regions and then subdivide them further into countries. You can mix and match, evaluat- ing regions of the world or getting more specific, without any focus on one or the other approach.
Stay regional and you can get a little more diversification than if you just bought one particular country. The flip side is that if the region is not doing well, but one or two of the countries in it are, then you could miss out on making some money. The best thing to do is to put together a list of ETFs that is subdivided into two sections. One section should have ETFs that represent stocks according to regions of the world and the other should contain ETFs that represent stocks in individual countries.
Remain consistent in your trading strategy; rely on your chart analysis to determine which ETFs you want to own at any one time.
Dividing up your timing world
It’s a pretty big world, and from a timing standpoint slicing it up into neat sections that you can analyze individually is a big help. You can divide it geo- graphically, or you can divide it by market capitalization, meaning that you group large markets such as Europe and Japan in one category and smaller markets such as Southeast Asia and South America in another category. I prefer the former method, as it forces me to look at things via details.
In this section, I show you how to organize a handful of funds by market capi- talization. The examples are some of the ETFs that I use on a regular basis.
As you get better and figure out what regions of the world you like, you can develop your own relationships and apply this method to your own list. You can find lots of ETFs at the American Stock Exchange Web site (www.amex.
com) and also at the New York Stock Exchange Web site (www.nyse.com).
Here are the most liquid and prominent global markets, and these ETFs are representative of the action that takes place in these markets:
✓ Japan: For Japan I use the iShares MSCI Japan ETF (EWJ). This fund is designed to follow the action in the MSCI Japan Index and concentrates on large cap stocks, such as Honda Motor, Sony, and Toyota. I combine EWJ with the Currency Shares Japanese Yen ETF (FXY) for a currency hedge when appropriate. (See the section “Considering the Currency Effect” earlier in this chapter to see how to use a currency ETF as a hedging mechanism for an international ETF.)
Japan is an excellent region to time because it’s a big liquid market, and the stock market in Japan can move in one direction for very long peri- ods of time. That means that when a trend is in place, it may continue in the same direction, and you can make money just by staying with the trend.
✓ The world without the United States: For Europe and a diversified Pacific Basin and Asian exposure, I use the iShares MSCI EAFE Index Fund, which mirrors the action of the Europe Australasian and Far East Index.
When the EAFE trend turns negative I use the Short EAFE ProShares ETF (EFZ). The EAFE can but does not always move in the same direction as the U.S. market. By investing in this ETF, you may get some diversifica- tion, and some currency benefit, if the dollar is weak.
✓ Australia: To trade Australia by its lonesome, you can use the NETS Trust Australia ETF. To hedge the exposure, you can use the Currency Shares Australian Dollar ETF (FXA). Australia tends to move higher when natural resources and commodities are in bull markets. That means that these ETFs can deliver gains when other markets don’t.
✓ China: China is a growing market. Again, as with other ETFs that I like, China’s market can trend in one direction for a long time. This makes the country and its stock market excellent timing targets.
✓ Brazil: Brazil is the largest economy in South America and its stock market is a big player that’s frequently targeted by large mutual funds from the United States and Europe. That means that it’s liquid. Its currency, the real, is also an excellent timing vehicle.
The New York Stock Exchange lists more than 20 international ETFs, and the American Stock Exchange over 50. You find single country ETFs, regional ETFs, strategy ETFs for growth, value, large and small stocks, and even inter- national ETFs that offer the opportunity to invest in specific sectors such as oil, water, and consumer goods.
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You can spend a lot of time figuring out the nuances of each and every single ETF, which is plausible but might be a difficult way to get started. Or you can do what I’ve found useful, to use a small sample of ETFs and to become very familiar with the way they behave. I use just a handful of ETFs for timing the international markets.
Choosing International ETFs
For me, trading international ETFs is all about simplicity, liquidity, and ease of hedging. Even if a market and an ETF are attractive from fundamental and technical standpoints, I won’t trade them unless they provide the right answers to the following questions:
✓ How easy is this ETF to follow? Because of the time factors that govern my daily schedule, I have to do as much as I can with as little effort as possible. If I pick way-out-of-the-mainstream stuff to invest in, I have to spend a lot of time researching trivia, and that would lead me to miss something else. So I pick funds that are easy to follow and that are rep- resentative of where the big money moves. If I can’t find a quote when I need it on my PDA, or via basic computer access, I just won’t bother with it. The ability to know what your money is doing at any time is the key to success, especially as a market timer.
✓ Can I short sell this sector of the market? Because I generally use only a handful of ETFs, I want to know that I can sell short whatever each one represents if things turn down.
You can sell most ETFs short by shorting the individual shares as you would with any stock. But that involves margin, and there is always the difficulty of finding ETF shares that you can borrow to sell short.
Instead, as much as possible, I look for ETF pairs where one ETF goes long, and another does the opposite by shorting shares. That way I can just click one button and I’m on my way.
✓ Can I hedge the exposure to this ETF? You can hedge your exposure to country and region ETFs by using a good currency play. For more details, see the earlier section “Considering the Currency Effect.”
Another way to hedge ETFs is to buy another ETF that does the oppo- site. I show you how to do that in the next section.
The Chinese market is an excellent place to illustrate the concept of using a pair of ETFs — one that is long the underlying market, and one that is short the same market — and the simple but careful method of making your timing decision. Here are some important steps to take as you make your way into international timing via ETFs: