Don't sell the dollar short... or listen to pundits

February 24, 2017 09:00 AM

The past year was great for demonstrating one of the common investment fallacies that has kept behavioral finance specialists in expensive cars for many years — investors’ willingness to listen to a paid professional’s forecast for the market no matter what their track record. You might think about popular talking heads on cable business networks, but no one has had a better run in the last few years than macroeconomists. First, they told you that there’s no way British voters would back Brexit, or that if Donald Trump won in November it would trigger a massive market sell-off. 

Making predictions might be a great way to grab headlines, but as the core component of an investment strategy, it leaves something to be desired. It’s best to favor the singularly unsexy strategy of “playing the percentages.”  Think of it like playing basic strategy at a blackjack table; if the dealer is showing 10 and you’ve got 17, the odds say to hit and though you might lose the hand, if you play long enough you’ll come out ahead.  

Consider the “Trump Trade” where investors rushed to reprice their 2017 outlook following the election.  Expectations that Trump would be pro-infrastructure helped to send interest rates surging, leaving defensive plays like utilities in the dust while sending bank stocks into nosebleed territory. But the real winner was Uncle Buck with the dollar soaring to levels not seen since 2003. So what’s the easy story for paid forecasters to put together? Buy foreign funds because the dollar’s going down, of course.  

And at first glance, people seem to be buying it. We currently rank more than 1,000 funds based on several behavioral data points including price momentum; short interest (or the put-call ratio (P/C)) and international funds seem to be headlining the list at the moment with the iShares MSCI South Africa ETF (EWA) at #1 followed by the iShares MSCI Brazil Capped ETF (EWZ) at #3, and there are another 20 rounding out the top 100 funds. So, ,on the surface it might seems like everyone already is betting the same way and ruining the payoff potential, but look into the details and a very different story emerges.  

The South Africa Rand is one of the few currencies that’s maintained its value against the dollar since election day, but investors buying up EWA in anticipation that might continue isn’t the reason the fund is in the top spot. While EWA was up through the end of the year, the fund has actually seen its price momentum score decline as its strong rally at the start of 2016 lost steam. High implied volatility, P/C and short interest scores were what pushed it into the top spot, and EWZ owes its spot at #3 to much of the same although its momentum score is higher overall.

In fact, reranking our universe just on price momentum brings up an almost entirely different list of funds where master limited partnerships and currency-hedged international equity funds like the Deutsche X-trackers MSCI All World ex U.S. Hedged Equity ETF (DBAW) dominate as some traders clearly anticipate the dollar holding onto its gains in the near-term while also looking at international equity exposure for more upside potential in 2017 (see “International play”). And looking at the 100 funds with the highest momentum scores, DBAW is just one of more than 30 international funds, hedged and unhedged, that make up that list with exposure to the euro being the most common factor among the unhedged. 

So, while the paid prognosticators might be saying the dollar can’t hold these levels, traders are positioning themselves as if a strong dollar is here to stay.”

About the Author

Matt Litchfield is content editor for ETF Global (ETFG.com) and is responsible for all posts and new product updates on ETFG.com. @ETF_Global