ETF Strategist - Fixed Income

EU Crisis Turns Has-Beens Into Hot Currencies

With weak employment reports in the U.S., lackluster growth numbers in China and the seemingly endless euro-zone crisis, the global economic outlook is decidedly gloomy.

For investors trying to protect themselves from the gathering storm, currency investing — especially through exchange traded funds, — can play an important role, says Laurence Wormald, head of research at SunGardAPT.

“They are good hedges for investors who aren’t able to play directly in the currency markets,” through futures or other instruments, he says.

There are more opportunities to express bullish economic views than bearish ones through currency ETFs, but investors looking for protection from a downturn still have reasonable options.

The key is to focus on currencies that are behaving like safe havens — strengthening when the news is bad, and vice versa. These days, given the debt turmoil in the E.U., that would be the dollar and the Japanese yen.

Gary Gordon, president of Pacific Park Financial, an investment advisory firm, says he is “not buying anything at the moment until the world rights its ship." But for investors who do want to trade on a bearish view of the global economy, he suggests the PowerShares DB US Dollar Index Bullish Fund, which tracks a widely used dollar index, and CurrencyShares Japanese Yen Trust, a pure play on the yen.

Michael Rawson, an ETF analyst at Morningstar, also points to the Powershares dollar ETFs — there is a Bearish Fund as well as the Bullish Fund — as options for taking a position on the global economy. But he has mixed feelings on their structure.

Both track the U.S. dollar index, which is based on a trade-weighted basket developed in the 1970s by the Federal Reserve . Rawson points out that those weightings don’t really reflect current trade balances: for example, there is no emerging-marketcomponent, and “the dollar bullish version has a 57 percent weight toward the euro.”

With all that's going wrong in the euro zone, that may not be what investors want in a currency safe haven. 

Until last year, the Swiss franc also tended to perform like a safe haven when economic times got tough. But as the European debt crisis festered, and the Swiss franc grew more appealing by contrast, Swiss authorities tired of trying to curb their currency’s strength announced in September that they would set a floor under the currency’s relationship to the euro.

They have solved their strong-currency problem — and then some. The Swiss franc has dropped significantly as the euro has weakened, and at the moment, it is not offering a safe port in a storm.

Still, both the Swiss franc and the yen have netted gains for bearish portfolios in the past. Guggenheim’s Anthony Davidow notes that “last year at this time, there was a flight from the euro, and buying of the Swiss franc or the yen.”

Tom Lydon, chief executive of Global Trends Investments, an investment advisory firm, recommends including the CurrencyShares Swiss Franc Trust, a single-currency ETF based on the Swiss franc, in a bearish portfolio.

“With more problems popping up out of the euro-zone peripheral states, the depressed franc will again attract greater interest from safe-haven investors, especially from euro-currency holders.

"If the Swiss National Bank doesn’t step up to reign in the currency, there is a high probability that we will see another round of franc appreciation," he says. Lydon also likes the PowerShares dollar bullish fund as the best ETF play on the dollar.

However you decide to express a bearish view, it’s a good idea to include currencies — probably in the form of ETFs — in your plan.

“Many investors are going into the summer and they don’t have the stomach for the stock market any more,” says Lydon. “A way to possibly take some of that cash that you have on the side is to look at those currencies that are safe and stable.”  

Disclosure: Tom Lydon is an independent director on the board that oversees some Guggenheim Investments mutual funds and non-currency ETFs.