Conventional wisdom says to create a diversified portfolio of markets. However, it doesn’t do much good if those investments tend to move in the same direction in response to changing market conditions. Combining U.S. and international investments can result in a better-diversified portfolio whose holdings don’t march in lockstep – so when some go up, others go down, and vice versa. The result: a potential reduction in the volatility of your total portfolio in the long-run. Since International stocks may not always trend the same as U. S. stocks, I prefer to rotate between these markets rather than allocate to them all the time.

International stock markets can be broadly divided into developed countries and emerging markets. The MSCI EAFE Index includes developed countries. The MSCI Emerging Markets Index includes smaller countries.

So far in 2018, International stocks are down. Developed markets are down -4.6% and Emerging Markets are down -8%.

One reason International stocks and trending down for U. S. investors is the Dollar has trended up. Currency risk is a significant risk facing investors in International and emerging markets.

This is an example of why it’s useful to understand the driver of returns and how markets interact with each other.

Below is the same change, but I’ve added the U.S. Dollar Index.  The Dollar started trending up in April, which is no surprise with the interest rates rising, which means the yield on our Dollar is rising. Around the same time the Dollar trended up, we see these International stock indexes declined. These ETFs are traded in U.S. Dollars, but they are International stocks in other countries, so they are impacted by a change in currency.

If we wanted exposure to these markets, but want to hedge off the currency risk, we could instead get our exposure with the currency hedged ETF. The currency-hedged ETFs Seek to reduce the impact of foreign currencies, relative to the U.S. dollar, on your emerging markets allocation

The iShares Currency Hedged MSCI Emerging Markets ETF seeks to track the investment results of an index composed of large- and mid-capitalization equities from emerging market countries while mitigating exposure to fluctuations between the value of the component currencies and the U.S. dollar.

I’ve compared the non-currency hedged Emerging Markets ETF below to the Currency Hedged Emerging Markets ETF. I highlighted the uptrend in the Dollar with a black dotted line. You can see up until the time the Dollar started rising, where I marked with a black arrow, the two ETFs were trending close. Since then, their price trends began to diverge. As the Dollar gained and the Emerging Markets stock ETF declined, the currency-hedged ETF of the same index fell about half as much.

To be sure, I’ve zoomed in the show only the past 3 months of the price trends.

So far in 2018, the U.S. Dollar is rising, and International stocks are falling, but it doesn’t seem to be just the rising Dollar driving them down.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

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The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.