Three ETF Plays For Euro/Dollar Parity

by on May 10, 2010 | Updated November 8, 2012 | ETFs Mentioned:

The tumultuous last week has sent a shock wave through global equity markets, with major indexes slumping as a wave of risk aversion crashed over investors. The worst of the fallout from the deteriorating situation in Greece was felt closest to the eye of the storm, as European markets plummeted and investors sought to sell anything denominated in euro. Thus far in 2010, ETFs in our European Equity ETFdb Category are down on average 15.5%. Leading on the downside are the iShares MSCI Spain Index (EWP: down 29.9%), iShares MSCI Italy Index Fund (EWI: down 26.3%),  and SPDR DJ STOXX 50 ETF (FEU: down 23.9%). Exacerbating the weakness in stock prices is a crumbling currency; the euro has plunged against major rivals over the last week [see Free Report: How To Pick The Right ETF Every Time].

While some are hoping that the worst has passed for the troubled region after the large bailout was approved by the euro zone and the IMF, others are not so optimistic. BNP Paribas recently revised its Q1 2011 forecast for the euro down from $1.22 to parity. “We had feared that the structural weakness of the euro zone, due to the increasing economic divergence, would make it more difficult to obtain an optimal policy response, said Paribas. “This has played out, but the inner EMU bond spread divergence and its impact on capital flows has been more severe than had been initially anticipated.”

Paribas was clearly discouraged by the events of recent weeks, and sees the difficulties encountered by European governments as a sign of things to come. “Now that the fiscal option has been used without much success it will be down to the ECB to come to the rescue of the EUR. Europe will change from using fiscal tools, attempting to heal European divergence with monetary instruments, sending the euro massively lower,” the bank said (also make sure to read Six ETFs To Watch As Greek Drama Unfolds).

This extremely bearish prediction from Paribas obviously isn’t guaranteed, but their argument for dollar/euro parity has some weight behind it. Below, we have highlighted three ETFs that could benefit if this prediction turns into reality and the once mighty euro drops to parity against the dollar (For more ETFs that could benefit from a decline in the euro see Five ETFs For A Tumbling Euro).

PowerShares DB USD Index Bullish Fund (UUP)

Arguably the biggest beneficiary of a weak euro would be the U.S. dollar. As more investors suffer a crisis of confidence in the euro zone, it could push more investors to the relative safety of the greenback. According to the fund’s fact sheet, UUP has close to 58% of its assets in futures contracts that are long the dollar against the euro. UUP has been one of the few winners in the recent turmoil, producing a gain of 3% over the past week and 5% over the past three months suggesting that as the euro struggles the dollar will strengthen (technical analysis is often used for currency trading; see UUP’s technicals page here).

iShares MSCI Sweden Index Fund (EWD)

Thus far in 2010 the Sweden ETF has been bucking the trend of sharp declines across Europe; the fund is only down 4% this year, far and away the best performer in the Europe Equities ETFdb Category. This is due in large part to the country’s avoidance of the euro, and thus the flight away from euro-denominated assets. Moreover, Swedish companies buy many of their raw materials from euro zone nations while exporting to other non-euro users such as Norway and the U.S. Should the euro continue to sink, it could be great news for investors in EWD which have already begun to experience the benefits of investing in the Swedish economy relative to other European nations. The fund is overweight in financials (26.1%), telecommunications (21.8%), and industrial materials (21.4%) while maintaining minimal allocations to technology and utility firms¬†[see Actionable ETF Trading Ideas].

WisdomTree International Hedge Equity Fund (HEDJ)

For investors seeking to maintain (or even increase) equity exposure to Europe but wary of too much exposure to the euro zone currency, HEDJ may make an interesting choice. The fund, which tracks the WisdomTree DEFA International Hedged Equity Index, offers exposure to the EAFE region (i.e., non-U.S. developed markets) while neutralizing exposure to fluctuations between the value of the U.S. dollar and non-U.S. currencies reflected in the index. To do this, HEDJ hedges out currency exposure through futures contracts (see EFA vs. HEDJ: A Better EAFE ETF?). HEDJ’s strategy may help to mitigate some of these impacts should the euro continue its decline further. In addition to Continental Europe, the fund allocates a sizable portion of its portfolio to the UK (19.1%), Japan (12.4%), and Australia (9%), allowing investors to achieve diversified international exposure with less currency risk (see more of HEDJ’s Holdings).

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