Euro Pop: A Lesson in Crowd Mentality

Breaking down a pair of German ETFs in light of the euro jump

by Adam Warner

Published on Jun 4, 2015 at 9:43 AM

Remember all the way back earlier this week when we noted the popularity of a fund that tracked German stocks minus the currency risk? The thought was that Europe would keep rising thanks to their quantitative easing (QE), but that same QE made the euro itself unattractive.

So a fund that got all the stock gains but didn't expose you to the inevitable euro drop represented the best of all worlds. I noted, though, that since everyone knows all that already, it's not likely to outperform going forward, seeing as it's already priced into the markets. 

Well, funny thing about that on Tuesday. This, from Bloomberg:

"The euro rallied the most in 10 weeks versus the dollar amid optimism that Greece is moving closer to ending months of acrimony with creditors and lessening the threat of default." 

Now, I write a lot and make a lot of "bold" predictions, and something like 12% of them come to pass. But hey, this one bizarrely came to pass in about 10 minutes. No, I didn't call a euro pop, just that it's silly to assume that a whole bunch of "knowns" are somehow not already priced into assets.

It's important to note also that until very recently, hedging the currency has, in fact, been the right way to play this. Here's a comp of two ETFs in 2015: One is the Wisdom Tree Germany Hedged Equity Fund (DXGE) -- "The Index and the Fund are designed to provide exposure to equity securities in Germany, while at the same time hedging exposure to fluctuations between the value of the U.S. dollar and the Euro" -- the other is the iShares MSCI Germany Index Fund (ETF) (EWG).

 

150604Warner1

 

And DXGE has clearly outperformed, up 15% vs. a still great 10% for EWG. But that outperformance is waning big time this week, thanks to optimism on some agreements over Greek debt (yes, I'm sure this will go smoothly). Here's a comp over the last five days.

150604Warner2

The currency hedge now weighs the performance down. The point is, of course, that nothing lasts forever. Especially these concept trades that everyone piles in on. They tend to beget violent counter moves, like the pop in the euro this week.

It's probably still right to use DXGE if you want to buy Germany. Just know you have to withstand some shakeouts like this.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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