ETF Update: How Currency Moves Affect Your Positions

ETF Investors hope to achieve the right level of diversification. 

Making sector-specific investments provides a chance to beat the market averages through focus.  Buying ETF's lets you avoid some of the risks that come with individual stock purchases.

An ETF portfolio can be very concentrated, or it can represent several diverse sectors.  Sometimes there is less diversification than one might think.  There can be an underlying theme, creating a correlation in the performance of apparently unrelated sectors.

Such is the current case with many attractive sectors which are all linked to weakness in the dollar.  This week's ETF update takes a closer look at currency moves and the effects on an ETF portfolio.


What do we mean by an "attractive sector?"

study sectors continually, looking at the charts and ratings of
hundreds of ETF's.  Each week we provide a list of our top-rated
sectors for the next three weeks, along with some of our current
observations.  ETF investors can check out the list and compare our
findings with their own conclusions.

In our analysis, we consider Trends, Cycles, and a bit of Anticipation.  Since we apply
the model to nearly 300 ETF's, we call it the TCA-ETF system.  (For new
readers, there is a more complete description of our methods at the end
of the article.  We also have a free report with more detail on the system and results, available on request.)

The Macro View

From an overall market
viewpoint, our indicators continue in positive territory.  The key elements are as follows:

  • We now find 96% of our ETF's in positive territory (98% last
    week).  The average strength rating for the overall list is 31, down from 43 last week.  (A score of "0" implies the average long-term ETF
  • 70% (up from 24%) of our sectors are in the "penalty box."  This means that they
    are currently disqualified from the buy list for technical reasons. 
    You can think of this as a sophisticated "stop loss" rule, often
    applied in advance.
  • Our index package remains positive.  For this rating we look at the
    (both long and short)  for the S&P 500, the Dow, and the Nasdaq. 
    You can see these ratings is the results table for this week.

Focus on the Dollar

US equities have recently been trading in an inverse relationship with the dollar.  What is the nature of this apparent correlation?

In a review of the fundamentals, Currency Specialist Adam Kritzer takes a look at the relationship between gold and the dollar.  In particular, he analyzes theories from Peter Schiff.  Kritzer takes a careful and balanced view, concluding, "Still, perception is reality in financial markets. If investors want to
see a connection between a weak Dollar and strong gold, they will
simply contrive one."

Here is a look at the dollar, using the (trade-weighted) dollar index.


There has been a sharp decline from the March (multi-year) highs.  What does this really mean?

The currency specialists at The LFB provide an analysis that we find confusing.  They write as follows:

The main reason for the stronger dollar on Thursday was the sell-off in
the equity market after the Existing Home Sales report, which declined
2.7% in August compared to the numbers from July. During the equity
sell-off, gold and oil traded significantly lower, while the dollar
index hit new daily highs.

and later…

The caveat to that is the dollar not getting sold is a msjor [sic] swing
change in sentiment, if the swing change morphs into a near-term trend
on dollar buying, it will signal weakness in equities that will then
have followed the drop in speculative interest out of the crude oil

Our read is that there is inferred causation without the needed evidence.  US equities are currently trading higher when the dollar is weaker, but we do not see evidence that the stock market is driving currency trades.

What is the long-term relationship?  CXO Advisory always does an excellent job with such questions.  Using the dollar/Euro relationship (as good as any), CXO points out conflicting theories about whether a strong dollar or a weak dollar is good for stocks.

The overall conclusion?  Here is the CXO Summary:

The following chart tracks the dollar-euro exchange rate (dollars per euro)
and the S&P 500 Index over the entire sample period. During this time the
dollar generally weakens (the number of dollars per euro rises), and the stock
market exhibits fits of historically high volatility. Visual inspection suggests
that the exchange rate and stock market sometimes move oppositely and sometime
move together.

The rest of the article does what we have come to expect from CXO — looking at correlations and possible leading indicators.  Any serious reader should check out the entire article.

Our take?  We see two markets currently moving together without real evidence of causation.

In Betting on the Weaker Buck, MarketWatch outlines five different strategies for playing a weak dollar.  Two of these are reflected in our current ratings.  Whether this works has a lot to do with the time frame of the trader or investor.

Weekly TCA-ETF Rankings

We had a loss of about 4.2% last week, trailing the S&P 500 by about two points, mostly as a result of strength in the dollar.  Our current holdings, while lower in rank, still have good strength ratings.  We do not buy ETF's in the penalty box or those with poor liquidity.  We provide these ratings as information for readers who may not trade as frequently as we do.  Those signing up for our free weekly email update can also get the entire list.

We also note that this week implements what our modeling guru, Vince Castelli, calls an improved filter.  While the underlying model has not changed, the inputs used reflect our best efforts to improve the signal-to-noise ratio.  We have advanced the timing (the Anticipation factor) reflecting the recent "hot money" tendencies in ETF's.  This means earlier recognition and also faster moves to the penalty box.

As noted above, all of the macro market indicators remain positive, although a bit lower than last week.  Based upon the current model signals, we have maintained our bullish position in the Ticker Sense Blogger Sentiment poll.

the top sectors from our expanded universe of 280 ETF's.  The list
also includes the values for the broad market ETF's and their


Note for New Readers

Our weekly ETF Update is designed to assist both investors and
traders interested in ETF's and Sector Rotation.  Before turning to the
current rankings, let us undertake a review for readers new to this

Our Method.  In this past article,
we described our basic methodology and why we believe the rankings are
useful for fundamental traders and technical traders alike.  While we
urge readers to check out the entire article, the key point is that
ETF's pose challenges and opportunities different from investment in
individual stocks.  The fundamentals may be more difficult to assess. 
Even with a good grasp on fundamental trends, there is a lot of
technically-based trading in ETF's.  This means that those trading with a fundamental approach (and we do this as well) want to monitor the "hot money" moves.  Here is an article on that point.

The system synopsis.
We look at Trending sectors, Cyclical Sectors, and build in an element
of Anticipation for both entry and exit — thus the name of the model,
TCA-ETF.  While we do not reveal the exact methodology for spotting
trends and cycles, the system is not a "black box."  The basic elements
are used by many, and widely reported.  We even discuss the need for human analysis as opposed to black box trading.

We report the rankings
each week, now on the weekend with a one-day delay, using the Thursday
output from the model.  We monitor and trade this daily, and offer a
free report (request via the email address on the top left of the site)
for those interested in our weekly trading program.

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  • Mark Wolfinger September 27, 2009  

    Hi Jeff,
    “ETF Investors hope to achieve the right level of diversification.”
    Why? To reduce risk?
    Why not reduce risk with collars. Yes, profits are limited, but in return you get a guarantee of losses no greater than ‘whatever is acceptable to the investor.’

  • Lord September 28, 2009  

    A high(low) dollar is good(bad) for importers(exporters), not equities in general. One should compare Walmart with Boeing, not large cap in general.

  • Jeff Miller September 28, 2009  

    Mark — Absolutely. Options are an important part of risk control.
    As someone who has personal knowledge of your trading and analytical skill, I know that investors can profit from your books and training.
    It happens that I do not use options in this program, but I do in others.
    Thanks for the comment.

  • Jeff Miller September 28, 2009  

    Lord — Yes! It varies with the individual stock. Investors looking for international exposure might do it with certain US stocks. We do as part of our Great Stocks program.
    Thanks for pointing this out.

  • Lucy January 22, 2010  

    I recently came across your blog and have been reading along. I thought I would leave my first comment. I don’t know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.