Risk vs. Return in International Portfolios

After an unexpected move by the Swiss National Bank on January 15 to abandon its peg against the euro and the announcement of quantitative easing by the European Central Bank (ECB) on January 22, investors around the world have been forced to re-evaluate currency risk as part of their asset allocation decisions. For many U.S.-based investors, currency hedging continues to resonate as they seek out new opportunities in foreign markets. Over the past 10 years, foreign currencies declined modestly against the U.S. dollar.1 However, as we have highlighted previously, our analysis shows that we may currently be in the middle stages of a secular appreciation in the U.S. dollar. As a result, investors should continue to consider hedging investments exposed to foreign currency risk.

One way investors have historically managed volatility in their portfolios was through allocations to cash. By maintaining a portion of their portfolios in cash, investors would hypothetically be able to deploy capital when markets became undervalued. However, today’s interest rates environment is much different than it once was. From 2004 through 2007,short-term interest rates averaged 3.46%.2 Today, the U.S. 30-year bond only yields 2.40%.3 With yields this low across the yield curve, U.S. cash positions can provide a significant drag on performance. Today, the argument for short-term fixed income is that it reduces exposure to risk assets, albeit with considerably less income potential than in the past. However, volatility across asset classes is trending higher. Due to such low opportunity costs from short-term fixed income, hedging foreign currency risk via a long-dollar strategy provides investors additional flexibility compared to simply allocating to cash. As illustrated in the chart below, investors were able to have a significant impact on portfolio volatility while still capturing a large percentage of returns from their equity positions.

Dialing Down Risk while Maintaining Returns
Risk/Return Implications of Dollar Bull Strategies for International Equity Positions, 11/30/04- 11/30/14

Interestingly, even though the volatility of the dollar bull strategy was significantly higher than cash over this period, it actually reduced overall portfolio risk to a greater degree due to its negative correlation (-0.71) with international equities.4 In our view, the real value of bullish dollar strategies in the current market environment is for investors with long-term international holdings. Given that many of these legacy positions may have large unrealized capital gains, a bullish dollar currency strategy can help reduce volatility from currency markets while maintaining existing exposure. In our analysis over the last 10 years, investors would have been able to capture a large portion of the upside, while significantly reducing volatility. As illustrated in the chart above, a 20% allocation to a currency strategy would have been able to capture 94% of total returns while reducing volatility by 26%.

In our view, a blended approach to managing currency risk can help investors navigate increasingly uncertain markets. With volatility of many asset classes rising, deploying currency hedging strategies may represent one way investors can enhance risk- adjusted returns.

1 Source: Bloomberg, as of 11/30/14.
2 Refers to the three-month U.S. Treasury bill. Source: Bloomberg, 12/31/03—12/31/07.
3 Source: Bloomberg, as of 1/15/15.
4 Source: Bloomberg, as of 11/30/14.

Important Risks Related to this Article

Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations.

Blue-Chip Earnings Disappoint; Nasdaq Shows Distribution

The Nasdaq suffered another distribution Tuesday, as investors gave a thumbs down to earnings reports from Dow components Microsoft (MSFT) and Caterpillar (CAT). A weaker-than-expected durable goods report also weighed on sentiment. Major averages rallied nicely off lows in early afternoon trading but sellers came back into the market late. The Nasdaq took the hardest hit, falling 1.9%. It gapped …

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Copper Prices Drop As Demand Shows Weakness

Copper futures approached a five-year low as industrial profit last year posted the smallest gain in data that started in 2000 in China, the world’s largest metal consumer.
Earnings in 2014 increased 3.3%, Chinese government data showed. In December…

Treasury Bond Yields Stage Rebound From Record Lows

Treasury yields rose from record lows as Federal Reserve officials gathered to decide on the pace of future interest-rate increases even as the U.S. economic expansion shows signs of slowing.

U.S. debt rallied earlier after a drop in durable-goods orders and lower-than-forecast corporate results suggested a slowing global economy may be impinging on U.S. growth. Stocks pared losses and crude-oil futures rose amid reduced demand for Treasuries as a haven. Futures prices show a 51% chance the Fed will raise its interest-rate target from virtually zero by its October meeting.

“There are a number of cross currents affecting assets,” said Dan Greenhaus, chief global strategist in New York at BTIG. “Volatility has spiked. The path of rates is dependent on the likelihood of a Fed rate hike.”

Yields on 30-year bonds were little changed after dropping as much as seven basis points, or 0.07 percentage point, to an all-time low 2.3262%. The 3% security due in November 2044 traded at 112-22/32, at 5 p.m. ET, according to Bloomberg Bond Trader data.

The Standard & Poor’s 500 Index of stocks lost 1.3%, after declining as much as 1.8%. Crude oil futures added 1.3% to $45.73 a barrel in New York.

Treasuries have returned 2% this year, according to the Bloomberg U.S. Treasury Bond Index. They gained 6.2% last year.

International investors are flocking to Treasuries because yields are higher than those offered by other industrialized nations in the Group of Seven. Ten-year Treasuries yield an average 0.88 percentage point more, compared with an average of 0.27 percentage point during the past decade.

Yields in German, France and Finland have turned negative with the European Central Bank pledging to buy 1.1 trillion euros ($1.25 billion) of government debt to inject stimulus in the region.

“The relative value of Treasuries as an alternative sovereign debt continues to be a driving force for the Treasury rally,” said Jeffrey Caughron, chief operating officer in Oklahoma City at Baker Group, which advises community banks with more than $45 billion in investments. “You’ve got the double whammy — the international situation that argues for lower yields combined with the slowing growth trajectory in the U.S.”

Demand for durable goods — items meant to last at least three years — declined 3.4%, the worst performance since August. The report was forecast to show a 0.3% gain, based on a Bloomberg News survey of economists.

Microsoft (NASDAQ:MSFT) and DuPont (NYSE:DD) said a strengthening dollar weighed on results, while Caterpillar (NYSE:CAT) cut its full-year forecast.

Top Income Stocks: Hasbro Gains As Monopoly Turns 80

Traditional toys face tough competition from video games and other electronic gadgets, yet Hasbro (NASDAQ:HAS) keeps growing its bottom line.
IBD’s toys and games industry group lagged at No. 180 in Tuesday’s issue among 197 industry groups. But on th…

Icon, A Leader In Its Industry, Builds A Base

New drugs require clinical trials and those trials increasingly have taken place on an international stage.

Many top drug developers outsource an increasing share of trials to companies like Icon (NASDAQ:ICLR). Based in Dublin, Icon is one of the top five contract research organizations in terms of market share.

This month, Icon Chief Executive Ciaran Murray told a group at JPMorgan’s 33rd Annual Healthcare Conference that the contract research organization (or CRO) market was set to grow 8% per year through 2020.

Murray pointed to research and development spending and increasing market penetration by outsourcing providers. (He currently estimates outsourcers hold 35% to 40% of the total clinical-trial market.)

Icon’s strategy is to amplify that growth into double digits via acquisitions, of which it has made 12 since 2008.

It has completed its $143.5 million acquisition of Aptiv Solutions. Reston, Va.-based Aptiv is relatively small, but has operations in 16 countries.

A key target of the deal was its ADDPLAN statistical software. It is used by the U.S. Food and Drug Administration, European Medicines Agency and Japan’s Pharmaceuticals and Medical Devices Agency, and more than 50 top drugmakers, medical device companies and academic researchers.

Over the past six sessions, Icon shares have formed a handle with a 58.85 buy point. The base has both some positives and negatives.

The handle is high in the base and well above the stock’s 10-week moving average. The base is a second-stage pattern, and shares are trading tightly. These are healthy signs.

On the downside, the bulk of the base formed below the 10-week moving average, which can be a sign of weakness.

The other leading CROs are Quintiles Transnational (NYSE:Q), Parexel (NASDAQ:PRXL) and privately held PPD. All are based in the U.S. Another CRO leader, Covance (NYSE:CVD), is being acquired by LabCorp of America (NYSE:LH) in a $6.1 billion deal announced in November.

Analysts expect a 43% jump in earnings in Q4. For this year, EPS are expected to rise 18%, a slowdown from estimates for 56% growth in 2014. Sales growth recovered over the past three years to 20% in 2013. Estimates call for a 13% gain in 2014, slowing to 15% this year.

Retailers Starbucks, Lululemon Again Hit New Highs

New highs from the retail sector have stepped up in recent sessions.
Starbucks (NASDAQ:SBUX) followed through on Friday’s breakout, adding 0.22 to a new high Tuesday. On Friday, shares gapped past an 84.30 flat-base buy point after reporting fiscal …

Apple, Chipotle: Stocks Driving This Top Mutual Fund

The $26.4 billion T. Rowe Price Blue Chip Growth Fund is back on track.

After outperforming the S&P 500 and its Morningstar Inc. large-cap growth peer group in the third quarter, the fund lagged in Q4. So far this young year, going into Tuesday the fund’s 1.89% return is topping both the big-cap bogey’s 0.00% and its peer group’s 0.56%.

Over the past three years the fund’s average annual return was 20.70% vs. 17.30% for its direct rivals and 18.49% for the S&P 500.

This top stock mutual fund has been driven by a portfolio whose average IBD Composite Rating is a pumped-up 75.

The Composite Rating reflects factors such as earnings growth and relative price strength.

Forty-eight of the fund’s 139 holdings as of Dec. 31 had a Comp Rating of 90 or higher. A 99 Rating is tops. Investing in stocks can lead to big gains.

Among those top-rated stocks is Chipotle Mexican Grill (NYSE:CMG). The fast-casual Mexican restaurant chain has opened Southeast Asian eateries and a pizza business.

Shares are up 48% over the past 52 weeks. Trading around 718, they’re extended past a 675.34 buy point. But the stock is shaping a follow-on three-weeks-tight pattern with a 728.07 buy point.

Earnings per share grew 12%, 23% and 56% the past three quarters. The company will announce Q4 earnings Feb. 3.

American Tower REIT (NYSE:AMT) is up 28% over the past 52 weeks.

Trading around 100 in the stock market today, shares are within 6% of a 106.30 buy point in a flat base.

Infrastructure Play

The company owns cell towers that are used by wireless service providers and TV and radio broadcasters. It benefits from carriers upgrading their networks to 4G. EPS grew between 22% and 29% the past five quarters.

LinkedIn (NYSE:LNKD) is up 10% in the past 52 weeks. But, trading around 222, through midday Tuesday shares had fallen below their 10-week moving average after a failed breakout over 238.87.

The stock is working on a new base with a 243.35 buy point. Its mobile revenue and headhunter services have shown good growth. It reports Q4 earnings Feb. 5.

Fund manager Larry Puglia added Shire (NASDAQ:SHPG), an Irish drugmaker, to the portfolio in Q4.

Shire’s Vyvanse, a treatment for attention deficit hyperactivity disorder (ADHD), and hereditary-angioedema drug Firazyr have seen strong demand.

EPS grew 24%, 36%, 41%, 42% and 60% the past five quarters.

Trading around 221, the stock is 1% over its 218.03 buy point in a cup-with-handle base.

The fund more than doubled its stake in Actavis (NYSE:ACT) to a 0.94% weighting in Q4. Acquisitions have been a key to the Ireland-based drugmaker’s growth.

Shares are only 3% above their 272.85 buy point after a late-stage breakout. Actavis gave upbeat guidance for Q4 at a recent JPMorgan conference.

Apple (NASDAQ:AAPL), with a Comp Rating of 89, is up 44% in the past 52 weeks. Shares are meeting resistance at their 10-week line as a potential base forms.

IPhone sales are strong, but iPad growth is slowing. Apple reported Tuesday that fiscal Q1 earnings grew 48%, double analyst expectations. EPS grew 6%, 15%, 20% and 20% the prior four quarters.

Michaels, Ulta Beauty Help LeadSpecialty Retailers

Ranked No. 19 out of 197 groups in Tuesday’s IBD, specialty retail is one of a number of retail industry groups doing well.
Michaels (NASDAQ:MIK), Ulta Beauty (NASDAQ:ULTA) and Italy’s Luxottica Group (NYSE:LUX) are performing especially well amid …

Trend In Fund Buying Mixed For Sector Leaders

A stock that attracts fund money is worth attention. Combine that knowledge with IBD’s Accumulation/Distribution Rating and with the up-down volume ratio, and a fuller picture emerges. Let’s look at the nine Sector Leaders, as of Tuesday’s IBD. Akorn (AKRX): Funds boosted their stake 10% from midyear to year-end 2014. Those opening new positions in Q4 included Fidelity Contrafund and Fidelity …

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