The U.S. stock market has rebounded after Tuesday’s big decline. But, in many ways, the volatility caused by Italy’s political turmoil is validation of an old trend.
Things have been uncertain on the other side of the Atlantic for some time now. The most visible sign of tensions were manifested in the Brexit referendum that shook the world two years ago. That’s the symptom, not the root cause of turmoil in Europe.
Remember, Conservative leader David Cameron had been critical of the European Union for years prior to the 2016 Brexit vote and represented a view that was widely held.
And, outside the U.K., there are plenty of other factions that are less than pleased with the state of affairs in the EU. Italy is proof positive of that, with one party leader saying after the recent vote: “Today Italy is not free; it is occupied financially by Germans, French and eurocrats.”
Look on the bright side — at least it makes we Americans feel better about our own governmental messes!
Anyway, if you’re concerned about how events in Europe could affect your portfolio, here are a few simple ways to hedge via targeted exchange traded funds (ETFs).
Europe Hedged Equity Fund
The WisdomTree Europe Hedged Equity Fund
HEDJ, +0.75%
is one of the most basic ways to play Europe but insulate yourself from some of the risks associated with anti-EU sentiment. That’s because the fund provides exposure to the European equity market but also hedges against the potential of a weakening euro vs. the dollar.
The Federal Reserve is all but certain to continue on its course for higher rates; right now, the CME’s “Fed Watch” tool predicts a 76% chance of a rate increase at the policy makers meeting in June, one of at least two more anticipated rate increases in 2018. Meanwhile, Europe has not made any clear signs toward tightening its policies. In fact, investors are putting only 30% odds on a European Central Bank increase over the next 12 months after the turmoil from Italy’s vote.
If you want to play Europe, it pays to do so in a way that hedges against a weakening local currency. Consider that the SPDR Euro Stoxx 50 ETF
FEZ, +2.13%
which shares six of the same top 10 holdings as the WisdomTree Europe Hedged Equity Fund
HEDJ, +0.75%
is down almost 5% this year while its hedged cousin is actually up 2%.
Of course, things can sour in a hurry if the euro gets its footing or the dollar stumbles. But given events lately in Europe and the likelihood of continued Fed tightening in the U.S., that seems unlikely.
Minimum Volatility Europe Hedged Equity Fund
If you want to add an extra layer of protection to your European strategy, the iShares Edge MSCI Min Vol Europe Currency Hedged ETF
HEUV, -0.24%
has you covered. The name is a mouthful, but essentially this fund aims to hedge your investment by managing fluctuations between the euro and dollar, just like WisdomTree Europe Hedged Equity Fund
HEDJ, +0.75%
with an added bias toward low-volatility stocks.
That means low-risk sectors like consumer staples take a big place here, with spirits purveyor Diageo
DEO, +0.23%
and chocolatier Nestle
NSRGY, -0.42%
playing a big role, as well as weighting toward European health-care stocks like GlaxoSmithKline
GSK, +2.21%
and AstraZeneca
AZN, +1.32%
Minimum-volatility funds have gotten a bad rap over the past few years, mostly because of a rising market. However, like WisdomTree Europe Hedged Equity Fund
HEDJ, +0.75%
this hedged equity fund is up nicely — about 4% this year vs. trouble for other European stock funds.
U.K. Small-Cap Fund
While globalization can be messy and Britain’s plans for severing ties with the EU even messier, one subsector of the stock market in Europe that seems relatively stable right now is small-cap stocks in the United Kingdom. After all, while multinational financials have tons of red tape to figure out, smaller companies tend to be both more agile and less reliant on big macroeconomic factors like Brexit.
Enter the iShares MSCI United Kingdom Small-Cap ETF
EWUS, -0.09%
a fund that is tailor-made for the little guys, many of whom were the driving force behind Brexit to begin with.
Admittedly, this fund has more exposure to cyclical stocks such as consumer-discretionary picks that could get hit hard in a broad downturn. Top holdings right now include publishing company Informa and pest-control service Rentokil, among others, and it’s easy to imagine that a recession pinches these picks (and others) in the EWUS fund.
However, these small-caps are standing tall today and unafraid of big-picture economic and political debates. The ETF is slightly in the green this year, while the broader FTSE 100 large-cap index
UKX, +0.36%
is slightly in the red.
‘Enhanced’ Europe Fund
Another way to slice the European stock market to your advantage is to simply be more selective based on fundamentals. That’s what the First Trust Europe AlphaDEX Fund
FEP, +2.08%
offers, with a very selective process that includes a look at share price performance, book value, return on assets and sales growth, among other criteria.
It’s a glorified stock screener for Europe, sure. But right up until a week ago when European equities went to heck in a handbasket, the FEP fund was doing great; this ETF returned nearly 5% this year through May 22 vs. roughly half that for the S&P 500
SPX, +1.27%
and large-cap Euro Stoxx 50 indexes.
Of course, it’s worth noting that the alpha-seeking approach of this fund can swing the other way in a hurry, thanks to a healthy dose of mid-cap and small-cap companies. But for those looking for a more tactical approach to the eurozone, this fund is worth a look.
Gold ETF
If you’re really worried about a downturn in equities, it’s worth remembering that it’s really hard to not feel the pain in Europe (or anywhere else) regardless of your specific fund’s flavor. Case in point: The temper tantrums lately from U.S. stocks based on trade fears, or the 1.5% or so drop by domestic indexes on Tuesday in response to the Italy vote.
As the old saying goes (or the new saying since 2008, anyway), in a serious bear market, the correlations all go to 1 anyway. I mean, did cherrypicking sectors or geography help you when Lehman Brothers went belly up?
In other words, if you really think the worst is about to go down in Europe — spanning the spectrum between the breakup of the monetary union to the default of a member state to another Brexit-like referendum in Italy or elsewhere — then look for a truly uncorrelated asset like gold, not an equities strategy that is the equivalent of a Band-Aid on a gunshot wound.
Enter your old friend the iShares Gold Trust ETF
IAU, +0.08%
As I noted in March, gold has had a correlation coefficient of roughly negative -0.15. A perfect lack of any correlation doesn’t exist in the wild (1.0 is 100% moving in lock step, zero is 100% moving at random with no relationship at all), but that’s pretty damn close.
In other words, gold may truly be your best safe-haven asset if Europe falls apart. Because if past is precedent, the rest of the world will soon be next if that happens.
Source : MTV
