Below extract courtesy of a.m. edition of “Sight Beyond Sight”, the global macro trading commentary published by Stamford, CT-based macro strategy think tank Rareview Macro LLC.
“…For most of the second half of the year we have seen a surging dollar, and a falling euro. Nothing seems to be coming that will disrupt that.
Now a lot of US investors have asked why the WisdomTree Europe Hedged Equity ETF (symbol: HEDJ) performance has been sub-optimal. Specifically, why isn’t this “strong dollar/weak euro” play not playing out much like last year’s Japan trade (strong dollar/ weak yen) as we saw with WisdomTree Japan Hedged Equity (DXJ)?
As a reminder, DXJ is a portfolio of Japanese stocks with a currency hedge overlay (i.e. 100% of assets is hedged). So HEDJ is the European version of DXJ. The underperformance therefore is simply stock-related.
For example, HEDJ is a basket of European stocks (i.e. 100% of assets is FX hedged). The underlying basket is a Wisdometree dividend weighted basket. It does not quite have the same weightings as the iShares MSCI EMU ETF (symbol: EZU) which is market cap weighted & large cap equivalent or the iShares Europe ETF (IEV) or any other standard index, but it does have a very high correlation.
If you compare HEDJ vs. EZU (i.e. use Bloomberg COMP function, HEDJ in line one and EZU in line 2 and then change the currency next to EZU to EUR instead of USD) you will see performance come back in line with HEDJ as it displays the effect of the FX hedge.
So HEDJ is working exactly the way it should given how it is constructed and using HEDJ to get long European stocks and a weaker EUR is correct instrument for that view.
So the question becomes, how do you gain using HEDJ?
That depends on where you domiciled and what currency your “PnL” is denominated in.
For US investors, if you buy EZU you are synthetically long European stocks and synthetically long EUR exposure.
For US investors, if you buy HEDJ you are synthetically long the stocks but not long EUR exposure.
This is just like EWJ vs. DXJ for Japan. So when DXJ moved much higher it was favorable for US investors if their PnL was denominated in US Dollars.
In the end, the difference between HEDJ and DXJ is simply stock market performance, not the currency.
We walk into the upcoming holiday season asking if the underperformance in European equities is about to end, even though the fundamental backdrop remains very poor and regardless of the potential monetary and fiscal easing measures over the next couple of weeks?
If you believe the answer is YES than HEDJ is the correct instrument if you are a US equity investor and want to remove the euro from the equation.
According to the charts above, either on an outright or on a relative basis to the S&P 500, some might well have figured that out for themselves already.
For ourselves, we are struggling with this view and would argue that a fair amount of the narrative sketched out above is already in the price of the Euro. However, we are mindful that this morning’s German IFO data mirrors last week’s ZEW report, both of which beat expectations by a wide margin. We highlight this because all it takes is another 3-5% lower in the euro exchange rate and it will become easier for paid forecasters to argue that the core European economies – Germany and France – are finally starting to see the positive effects of a weaker currency come through in the data.
We are not bullish Europe by any measure. But like you, we are simply asking if long HEDJ ETF and long France/Spain bonds will become the new vogue trade?
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