Investing in Europe—not as straight forward as you’d think

Before we get started, here is my BNN show from Monday.

 

Should investors buy into the high flying European stock markets? The iShares European stock ETF (IEV-US) clearly broke out recently. There’s no overhead resistance ahead of it—the coast is clear for more upside. It’s a bit overbought and may pull back from here, but the overall picture looks bullish. But there are other factors that we Canadians should look at before buying this ETF or similar vehicles.

For one thing, this ETF is priced in USD – and reflects the European markets (as a basket) that are priced in Euro’s. So, the exchange rate between these currencies matters for North American investors.  Let’s take a look at the Euro vs. the USD. As you can see on the chart below, the Euro was contained from 2015 to mid-2017. Then it broke out. Since the breakout in mid-2017, it’s been contained within a smaller trading range (approx.. $1.15 to $1.21 USD). So, as far as converting the Euro to USD’s– the picture is neutral. American investors are not likely to make much in the way of gains or losses by owning a Euro-currency security so long as this consolidated pattern continues. Given that, we now need to see how our Canadian dollar compares to the USD. That’s because, if the Euro is more or less stagnant vs. the USD, it’s the USD that would affect us in owning an American traded ETF like IEV.

As the chart below shows, the Canadian dollar is – in itself – trading sideways or range bound vs. the USD. At this time it is, anyway. That range, which has been seen before, is about $0.78 – $0.83. So again, we have a more or less neutral looking position when looking at the loonie vs. the USD at this time. The longer downtrend is arguably fighting to break out to the upside, but there is no clear evidence of that break sticking yet—so I’ll call the loonie as range-bound for the time being when compared to the USD.

So…we have a flat Euro vs. the USD, and a flat loonie vs. the USD. This implies that buying a European ETF trading on a US exchange in US dollars is a currency- neutral move. Small movements in their respective trading ranges will affect the ETF pricing, but there is no dominant currency trend to motivate or repel us from investing.

 

Could the USD begin to move positively or negatively in the coming year vs. world currencies—thus changing these currency-neutral patterns? Possibly.

The US bond market is under some level of duress right now. Talk is for rising rates in the USA. That can be seen on the TLT (20 year bond) chart below. The rising trendline from last year is breaking. The last low on this ETF has not been breached – that’s a good thing for bonds, so far. If bonds do break down further ..this implies rising yields. Rising US interest rates are usually bullish for the USD. Always willing to thrown a monkey wrench into it – my colleague Craig Aucoin note that rising rates could initially be taken as negative for the dollar at first if the reason for a falling T-bond is due to lack of buyers rather than just Fed rate tightening.

Anyone confused? I am! The act of trying to out-guess world currency traders and their perception of treasury bond decisions and the implications of those decisions is a tough one. So too is the art of determining the timing surrounding the inevitable consequences of a world with “too much debt”. So, rather than try to foresee all of the potential developments of the USD vs. treasury bond demand, and the implications of Chinese demand for treasury bonds, or the consequences of fiscal policies –I’ll stick with the currency charts themselves. At this time, the situation appears currency- neutral for investing in a European stock ETF. And the stock charts themselves appear mid-termed bullish (although neartermed overbought) for the Euro stock index basket itself.

2 Comments

  • Keith I’d like your opinion on the effect of certain scenarios on the Utilities sector.
    There are a couple stocks I am contemplating to buy (Northland Power and Altagas, adding to Fortis which I own). They both provide a hefty dividend and both have been beaten down in 2017.
    How likely would the utilities sector be negativly afffected in the price per share by:
    1) higher interest rates which the BOC is contemplating going forward, albeit at a gradual pace and
    2) if there was a market pullback be it seasonal or just a healthy and possibly overdue correction.
    Obviously I like the dividends, the industry has some stability, and typically a low Beta. But I don’t want to chase dividends and I do wish to preserve capital given I am a retiree.
    Thanks

    Reply
    • Daddyo–there’s nothing wrong with holding this type of stock if you just want to collect the yield. They are not going to go out of business (well, there always some that have risk, but the big names are fine…). Having said that–sometimes these companies are leveraged – eg Fortis–this means that interest rates rising is going to disproportionately hurt their earnings. Not likely enough to disturb the dividend, but it may curtail dividend growth. Even if that isn’t the case–earnings are definitely affected by rising rates in a leveraged business, so the stocks are unlikely to see a capital gain from current prices for a while. They might even fall a bit more.
      The good news: At some point, the sector will have fallen enough to build in all potential interest rate risk. That is the point that a growth investor would want to consider them (technical base is the sign of the bad news being built in). Meanwhile, investors seeking dividends could be happy with their income from these stocks and not worry about the neartermed noise.

      Reply

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